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We’re all economists now (part one)

a man pushing over the word "crisis"The British/ European/ global economic downturn/ credit crunch/ crisis/ recession from 2008, and now making an unwelcome return in 2011/12, seems to have piqued many peoples’ interest in all things economic.

You don’t need to fully understand what exactly a hedge fund does, or what is meant by derivatives or naked short selling (if only it means what it sounds like it means), or that getting a ‘haircut’ now has another meaning, to want to know more about the economic reality that exists in the UK at the moment.

And for that, a sound grasp of the basics is more important that being an expert of each and every intricate financial term. But, thank you BBC for this very helpful financial glossary, all the same.

Here is an attempt to makes things a little clearer:

The principal narrative of the coalition ConDem government is that they inherited a huge budget deficit; that is the amount by which government spending in a year exceeds its income, in terms of taxes and receipts.

It is also referred to as Public Sector Net Borrowing (PSNB): the total the government has to borrow each year, resulting in it racking up a deficit, measured as a percentage of GDP.

By GDP, we mean the total economic activity of a country, in terms of all the goods and services it produces. It measures the health of the economy.

The deficit taken on by the coalition was worth £156.1bn, 11.1% of GDP (p.24), which was actually around £11bn lower than the £167bn forecast for the end of the financial year 2009/10, by the then Labour Chancellor, Alistair Darling, in his final budget.

It is important to note that this figure excludes the money spent bailing out UK banks (RBS, Lloyds TSB, HBOS) during the 2008 credit crunch – a total which has fluctuated wildly from a commitment to propping them up to the tune of £1.162 trillion back in 2007, to £612.58bn by March 2010, and then down again to £456.33bn at the end of March 2011.

Then there is the UK’s government debt, or its Public Sector Net Debt (PSND), which is the total amount of money the government owes. It is worked out as an aggregate figure, and is the accumulation of all the fiscal deficits, all government borrowing, accrued over previous years, and which is still to be paid off.

Thus, each year’s deficit gets added to the existing debt.

The present government inherited debt of £759.5bn or 52.7% of GDP, for the end of the 2009/10 financial year, according to Treasury figures (p.95) released in March’s 2011 Budget.

So, who exactly does the government owe this debt to?

In short, most of it is owed to us.

Debt can be divided into internal debt, money owed to lenders within the country, borrowed from those in the private sector, such as pension funds, investment trusts, building societies, and external debt, that owed to foreign lenders.

The UK Debt Management Office (DMO) is charged with managing the government’s debt through the sale of gilts (risk-free bonds), Treasury bills, and bonds. The latter act as the government’s debt security.

The government issues bonds, which are bought up by various bodies in the form of loans (debt investment), which it then has to pay back at a fixed (maturity) date, with interest.

UK government bonds are seen as relatively secure and risk-free investments as buyers know that they will always be repaid.

Pension funds and insurance companies are the biggest owners of government debt, making up almost a third of it.

The biggest increase in debt since 2007 has been caused by the bank bailouts, and the need for quantitative easing (printing money), in order for these financial interventions to have been possible.

And, about a third of debt is external, owed to overseas investors.

The second part of this three-part article puts all these facts and figures into context. It appears tomorrow.

One Comment

  1. Chris says:

    Interesting, but is it true to say that quantitative easing has added to the debt? QE confuses me a bit, as I thought this was an increase in the money supply purely for the repurchase of govt bonds?
    So it might be inflationary, but wouldn’t add to national debt, as it doesn’t have to actually be paid back?
    I’m also not sure why QE can be used to buy back bonds, but not buy more hospitals or fund the Olympics etc!

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