Government debt

Understanding Gross Government Debt: A Financial Lifeline or a Burden?

Imagine a country as a person, with its financial health measured by its gross government debt. This figure represents the total amount of money it owes to various creditors, both domestic and foreign. But what exactly does this mean for the nation’s future? Let’s dive into the complexities of government debt.

The Scale of Government Debt

In 2020, global government debt reached an astounding $87.4 trillion, making up a staggering 99% of GDP and 40% of total debt. This figure is not just a number; it’s a reflection of the economic policies and fiscal decisions made over decades. How did we get here? The answer lies in stimulus measures during economic recessions, which have been crucial for maintaining stability but also contributed to rising debt levels.

Measuring Government Debt

Government debt is typically measured as the gross debt of the general government sector. This includes all liabilities that require payment of interest and/or principal. The Global Financial System Manual (GFSM) recommends valuing this at market value for international comparability, ensuring a fair comparison across different countries.

The Debt-to-GDP Ratio: A Key Indicator

A country’s debt-to-GDP ratio is an essential indicator of its financial health. This ratio measures the total government debt as a percentage of the gross domestic product (GDP), which represents the value of all goods and services produced during a period. By comparing this figure, we can understand how much of a nation’s economic output is dedicated to servicing its debt.

Why Governments Borrow

Governments borrow money for various reasons, one of which is to act as an economic shock absorber. During times of crisis, such as wars or public health emergencies, governments need funds to cover unexpected costs. However, this borrowing can create a ‘deficits bias,’ where the tendency to run deficits becomes ingrained in fiscal policy.

A Historical Perspective

The history of government debt is as old as recorded financial transactions. Written records show public borrowing dating back two thousand years, with significant milestones like the founding of the Bank of England in 1694 revolutionizing public finance. Even during periods of high debt, such as Britain’s peak of over 200% of GDP in 1815, governments managed to pay off their debts through primary budget surpluses.

Debt and Economic Growth

There is a debate about the relationship between government debt and economic growth. Some studies suggest that growth rates are lower for countries with government debt greater than 80% of GDP. A report by the World Bank found that debt-to-GDP ratios above 77% (64% for developing countries) reduce future annual economic growth by 0.017 percentage points for each percentage point of debt above the threshold.

Debt Risks and Vulnerabilities

Excessive government debt can make a country vulnerable to a debt crisis, which can be costly and lead to an even greater fall in incomes. To avoid such crises, governments may want to maintain a ‘fiscal breathing space’ – enough room to double the level of government debt when needed.

Intergenerational Transfers

Government debt creates an intergenerational transfer, as beneficiaries of government expenditure typically differ from those who will repay the debt. This raises questions about fairness and sustainability in public finance.

Credit Risk and Inflation Concerns

There is credit (default) risk associated with government debt, particularly in countries without their own fiat currency. Historical examples include Spain’s repeated defaults, the Confederate States’ unrepaid debt, and revolutionary Russia’s refusal to accept responsibility for Imperial Russia’s foreign debt.

Debt Denominated in Foreign Currency

Issuing debt in a country’s own fiat money may be considered risk-free because it can be repaid by money creation. However, this is not always the case, particularly for sub-national governments or countries in the eurozone. Inflation risk arises when a central bank provides finance through debt monetization, leading to price inflation.

Contingent Liabilities

Most governments have contingent liabilities, which are obligations that do not arise unless a specific event occurs in the future. Examples include public sector loan guarantees, ensuring social security pension benefits, and spending for natural disaster relief. These liabilities should be included in government balance sheets but are not typically included in debt figures as they are not contractual obligations.

Conclusion

The journey of understanding gross government debt is complex and multifaceted. It’s a financial lifeline that can support economic stability during crises, yet it also carries risks if mismanaged. As we navigate the challenges of global finance, the role of government debt remains central to our economic landscape.