The Chancellor Rishi Sunak will need to lock in the low interest rates to take advantage of exceptional borrowing conditions
The Chancellor Rishi Sunak will need to lock in the low interest rates to take advantage of exceptional borrowing conditions © Simon Walker/HM Treasury

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Do the UK and many other high-income countries face the risk of severe fiscal crises? And is it advisable, as an independent Wealth Tax Commission recommends, for the UK to introduce a one-off wealth tax in order to reduce its soaring post-pandemic public debt? The answer, almost certainly, is no. We are using out-of-date metrics when assessing today’s fiscal risks. As important, we are missing a profound transformation in how macroeconomic stabilisation will have to be conducted. Whether we like it or not, we must rely on active fiscal policy.

Of the scale in the increase in public debt there is no doubt. In the case of the UK, the Office for Budget Responsibility forecasts a jump in the ratio of net public debt to gross domestic product from 34 per cent in financial year 2007-08 to 109 per cent in 2023-24, close to where it was in 1960, soon after the second world war. Yet, crucially, the debt interest paid by the government (net of the Bank of England’s holdings) is a mere 1 per cent of GDP, down from 2 per cent in 2007-08 and also the lowest in the postwar era.

Debt service is a far better indicator of the burden of debt than the ratio of the gross stock to GDP. Yet the nominal cost of debt is also defective. What matters, instead, is the real cost. Remarkably, the latter is negative: lenders are paying the government to borrow from them. According to the Bank of England, the UK government can now borrow at minus 2 per cent for 40 years.

Line chart showing Public sector net debt (PSND) as a per cent of GDP v entral government debt interest, net of APF as a per cent of GDP

Borrowing by the government for any programme or project with a zero or better real return must be profitable. Such a programme might be to sustain aggregate demand, in order to minimise long-term scarring caused by the pandemic. It might be investment in physical or human capital. Either should be economically beneficial, now that debt is so cheap, so long as it is implemented successfully. Indeed, things might be better even than that. As Jason Furman and Lawrence Summers of Harvard argued in a recent paper, a successful fiscal expansion might improve long-term fiscal sustainability if implemented in a depressed economy.

A slightly different way of thinking about this overall picture is that, so long as the growth rate is higher than the real interest rate, debt ought to be manageable: after all, under those assumptions, the present value of GDP is infinite. Today, the prospective growth rate must be above the negative real interest rate. If that were not true, the country would face a far grimmer future than anything the burden of public debt could inflict.

Yields on 10-year maturity gilts (%)

As things stand, then, the burden of public debt is not an issue. This is important because, as Furman and Summers argue, conventional or even conventionally unconventional monetary policy cannot be very effective any more. Indeed, a forthcoming paper co-authored by Summers and Anna Stansbury of Harvard argues that there may exist no monetary policy able to deliver full employment without dangerous side effects, including risks of serious financial instability. In the world of “secular stagnation” fiscal policy, they suggest, is the only sensible option.

In brief, it is quite wrong to think the UK faces fiscal Armageddon. Gross debt stocks relative to GDP are a useless metric. Yet there are risks, and they must be bigger for the UK than the US. Nobody has to hold UK debt or sterling. People, including British people, could decide to dump these assets, generating a collapse in the exchange rate, a spike in inflation and economic and political turmoil.

So what has to be done?

UK gilts yield curve, Dec 8 2020 (%)

First, it is essential to lock in low interest rates. The maturity of UK public debt has always been relatively long. The aim now should be to make it as long as possible, by taking advantage of exceptional borrowing conditions. It is true that the fall in real interest rates has been consistent over at least a quarter of a century. But this might reverse. Insurance against that risk must be taken out now, to the greatest feasible extent.

Second, the government needs to plan on how to close the structural fiscal deficit once the economy returns to normal. This is not urgent. On the contrary, it is far more important to sustain the recovery. But, especially as populations age, tax increases may be needed. It must plan how to do so now.

Last, but most important, the government must sustain confidence that the UK is run by sensible and competent people. Without that, the room to use fiscal policy might vanish. The chaos of the pandemic response did not help. Nor will a “no deal” Brexit. But a smooth rollout of the vaccine and swift return to a more normal economic life would help a great deal. There are indeed things to worry about. The level of debt relative to GDP is just not one of them.

martin.wolf@ft.com

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