Understanding government debt

Professor Frank Stillwell

 1. Any government can choose to go into debt. It may do so as part of a strategy of offsetting short-term economic recession. Or it may incur debt to finance more long- term nation-building economic expansion. Debt is incurred when the government spends more than it gets through tax revenues. A budgetary deficit can be funded by the sale of government bonds, in which case the government commits to pay interest to the holders of those bonds and to repay the principal at a future date. The purchasers of the bonds may be Australian or foreign: only in the latter case does government debt have any relation to foreign debt [and in practice corporate debt, rather than government debt, usually comprises most of foreign debt].

2. Government debt, like your personal debt, can be good from the economic viewpoint if it facilitates expansion of capabilities and choices. Government debt may enable the financing of productive activities or create a better economy/society/ environment for the future. For example, debt used to finance productive investments in infrastructure can increase the future economic wellbeing of the nation. Debt used to repair environmental damage or fund a transition to a more sustainable economy can also have a strongly positive effect.

3. On the other hand, government debt, like personal debt, can be bad if it creates a major burden of interest payments that reduces the amount of tax revenues that the government can spend on socially and environmentally worthwhile projects. Such debt impedes economic development and increases economic dependency. In the extreme, there can be a ‘debt trap’ if a government has to borrow yet more money in order to pay interest due on previous debt. This has happened in poor nations that have had to request debt cancellation through international agencies like the World Bank and the IMF.

4. In Australia the Federal government debt is about $101b, which is equivalent to 8 per cent of GDP. By comparison, the NSW State government debt last year was $29b which is equivalent to just under 8 per cent of the value of annual economic production in the State of NSW. It is sometimes said that Federal government debt is less problematic than State debt because the Federal government also issues the currency. But, in practice, both are very secure: indeed, it is unthinkable that either would be unable to service its debts. The only point at issue is whether the international ratings agencies give the borrowers a high credit rating: if they do not do so, for whatever reason, that means the government would have to pay a somewhat higher interest rate on any new borrowing. In practice, the interest rate on government debt is normally lower than for private sector borrowings because governments are the safest, most risk-free institutions. It is their capacity to raise taxes, rather than their capacity to increase the money supply, that is crucial in this respect.

5. Australia’ s government debt levels are much lower than most counties. For example: Japan: 178 per cent of GDP; USA: 54 per cent of GDP; UK: 75 per cent of GDP; France: 61 per cent of GDP; Italy 107 per cent of GDP (Source: OECD website at: stats.oecd.org/ Index.aspx? datasetcode=Gov_DEBT)

6. Government expenditure can be funded by tax revenues rather than debt. Most is. However, from time to time, debt is the better funding method. In a time of economic recession, for example, it is good to have a budget deficit (i.e. government spends more than it raises in tax revenues) in order to stimulate the economy.

7. The impact of federal government debt on individuals is complex. All people benefit, to some extent, if the borrowed money is spent on socially desirable projects, but some of their taxes goes to meet the interest payments on the debt. Those households, usually relatively wealthy ones, who lend money to the government (by buying government bonds) receive an interest payment. The presence of a bond market is generally regarded as a stabilising element in the economy and all benefit directly from that. (When Peter Costello, as federal Treasurer, declared his ‘zero debt’ ambition, the financiers were generally critical of his policy as economically unsound).

8. In the period since the global financial crisis began in 2007-8 some governments in other countries have resorted to ‘quantitative easing’ . This means that their central banks have been allowed to credit their own accounts with money, which can then be used to purchase government bonds and other securities and thereby boost economic growth above what it would otherwise have been. Creating ‘ money out of nothing’ in this way is a last resort when interest rates are approaching zero and the monetary authorities have no other means of stimulating the economy. In Australia an effective fiscal policy [the Rudd government’s ‘economic stimulus package’ ] helped to ensure that no such desperate measure would be needed. Well-timed adjustments of the official interest rate by the Reserve Bank, counter-cyclical fiscal policy by the Federal government and moderate levels of public debt have been effective as key elements in macroeconomic management.

9. Taking all the above circumstances into account, we can conclude that Federal government debt is not a problem in Australia, contrary to what right-wing politicians and some media commentators assert. However, what the debt is used for has to be kept under critical scrutiny.

10. The bigger problems relate to other forms of debt – household debt, foreign debt and ‘environmental debt’ – which have very serious implications. Indeed, this is where the real problems of debt lie – in overblown and unsustainable levels of household debt, over-reliance on international capital and anti-ecological economic activities that ‘borrow from the future’ with potentially disastrous environmental consequences.

For further reading consult Steve Keen’s Debtwatch blog: www.debtdeflation.com/blogs/

Frank Stilwell is Professor of Political Economy at the University of Sydney and an executive member of the Evatt Foundation.