parallax background


Where is the cash going to come from?

Almost everybody agrees that the government can't afford not to make huge interventions to keep businesses, households, workers and the economy afloat through the coronavirus crisis.

But the costs are now racking up.

The government is set to unveil a new multi-million-pound scheme for the self-employed, on top of the coronavirus job retention scheme for workers, cash handouts for small businesses, tax holidays and extra welfare payments. On top of that, it is also covering the losses of the railways and funding public spending on health.

In ordinary times, a recession means less tax and more spending, sending deficits higher as a result of the so-called "fiscal stabilizers"


But this is no ordinary downturn. It is - for an undefined period - shutting down large swathes of the economy. For some companies and sectors, we are talking not about less tax but zero tax, and the need for subsidies.

Massive borrowing is needed to spend tens - and perhaps hundreds - of billions more at a time when the tax base is eroding.

A new study by Richard Hughes, a former top Treasury official for the Resolution Foundation points out that previous pandemics have not led to a "V-shaped" recovery - as some had predicted - suggesting that the government should plan for a more prolonged downturn.

So we can just borrow the money, right? Well, at the very moment of this immense financing need, the markets that have routinely and reliably been throwing money at governments, almost for free, have taken fright.

There is basically a financial riot going on, and government bonds are no longer perceived to be equivalent to cash. Insurance companies and pension funds want and need actual cash, because their customers ask for it as global stock markets fall.

Banks, meanwhile, must deal with millions taking mortgage holidays for at least three months, a spike in non-performing loans and demands to lend more.

All the while, international investors are rushing to buy dollars. These events have distracted the traditional customers for government debt - lending cash to the Treasury - who are now far from guaranteed to be at the table. Indeed, the auctions of even some short-term UK government borrowing suggest a lack of demand in recent days.

That leaves one institution capable of swallowing this: the Bank of England.

And last week, after the announcement of the restarting of quantitative easing - the purchase from the open market of £200bn of borrowing - there was a little-spotted sentence in the official notice to markets on the purchase of gilts and corporate bonds. It said: "The MPC will keep under review the case for participating in the primary market."

In English, this means that the Monetary Policy Committee is considering buying UK government bonds directly from the Treasury.

Turning to central banks

Now, the Bank might well argue that this is to fulfill a statutory remit to keep markets functioning, in this case, that market is the gilt market for UK government borrowing.

But for many economists, this will step over a red line into what is called "monetary financing", the modern-day electronic equivalent of printing money - and the usual historical comparisons will undoubtedly be made with the 1930s.

For Mr. Hughes, the official who for three years was in charge of the Treasury's relationship with the government bond market, the unique global damage from the wretched pandemic, highlights a significant point.

"Governments may need to turn to their central banks for the liquidity needed to pay out against their commitments while government bond markets are temporarily disrupted," he says.

"Given current levels of market turbulence and the likely dramatic falls in revenue and increases in expenditure in the coming months, these actions may need to happen sooner rather than later."

He suggests that the government's effective overdraft at the Bank of England, the "ways and means account", could be lifted, massively, but temporarily

The key thing is to communicate that such a move would be temporary, and will be withdrawn after the outbreak is properly contained.

It is not clear whether the MPC is discussing this option today, or indeed discussing it in these terms. But last week Governor Andrew Bailey said "we do have an eye on what the effect of the government's financing needs are, and the government's very, very sensible responses to the crisis we're in.

"I just want to emphasize that we're not abandoning the very clear, central bank philosophy in terms of monetary financing because you know history tells us where that leads."

It goes against the grain of what central bankers do. There are famous cartoons hung up at the Bank decrying an ancient history of this type of move. But the UK will not be alone, many nations are now in this zone, not through excess spending, but the debilitating effects of a global health crisis.

A move in this direction could come very quickly

Who does the UK owe money to?

There are two types of debt: Government debt (Public sector debt / National debt) – The money the government has borrowed, primarily from the private sector. External debt. Liabilities the UK owing to the rest of the world – this is both private sector and public sector.

Who does the government borrow from?

The UK government borrows mainly from

UK pension funds/insurance companies (29%)

Private corporations / other financial institutions

UK building societies. (e.g. building societies buy government gilts to invest their savings to get a decent return.)

UK Banks

UK Private investors

Foreign investors (foreign banks and foreign investment firms (2018 approx 20%) Bank of England Asset Purchase Facility (Quantitative easing)

A pension fund will be interested in purchasing UK government gilts to gain a secure return on long-term investment.

A charity/firm with excess savings may purchase government gilts to get a good interest rate while it decides how to use the money. Retained profit from UK companies has increased in recent years, and corporations have become a bigger buyer of UK gilts.

A private individual may purchase gilts as part of a balanced portfolio of investment.

We owe money to ourselves

One feature of UK government borrowing is that 75% of the debt we are borrowing from UK citizens and UK institutions. It is like a transfer of pension funds to the government.


UK External Debt

Firstly, this is very different to government (national) debt. It is the total amount that people in a country owe to the rest of the world. It includes both government debt and private sector debt.

In the UK, external debt is currently over 430% of GDP (£6,200bn) The vast majority of this is liabilities by the banking and finance sector. UK banks external liabilities amount to over £4,000bn. However, it should be noted that this size of external liabilities is matched by UK external assets of £6,000bn.

Coronavirus: Government debt, an explainer

The Government’s debt may exceed £2 trillion by the end of this year. Over £200 billion of new borrowing could be needed. Much of this will be due to the coronavirus pandemic.

In this Insight, we look at the basics of what government debt is, how it is funded and who it is owed to. We pick out some of the key issues arising from the coronavirus pandemic.

What is government debt?

When the Government spends more than it receives in taxes and other revenues it has to borrow. This is sometimes referred to as the Government’s budget deficit. Broadly speaking the Government’s debt is the accumulation of its outstanding past borrowing.

Will UK Government debt increase?

The Government will need to borrow more during the coronavirus pandemic. Money is needed to finance its interventions to support workers and the economy, including providing loans to businesses. It will also need to borrow more because the slowing economy will increase Government spending and decrease its tax revenues.

Where has the Government borrowed from?

Over 85% of the Government’s total debt has been raised by selling gilts and bills, mainly to financial institutions (more on this later). Just under 10% is from National Savings and Investments (NS&I). NS&I is the Government-owned savings bank. It offers savings products, such as premium bonds, to the public. Other sources make up the remainder.

What are gilts and bills?

Gilts and bills are ways of loaning money to the Government. They are auctioned by the Debt Management Office (DMO). The DMO is the Government’s debt management agency. The sale of gilts and bills finances the Government’s borrowing.

A buyer of a gilt lends the Government money for a specified length of time. This is known as the gilt’s maturity. In return, the holder of the gilt receives an interest payment, known as the coupon payment every six months for the duration of the loan

When a gilt matures the Government pays the original amount loaned back to the holder of the gilt. The holder at maturity may not be the original buyer. Gilts are often traded on secondary markets by investors, pension funds and other institutions.

The DMO also sells Treasury bills, but a much smaller proportion of the Government’s borrowing is raised through these. Treasury bills are short term loans to the Government of less than a year.

So the DMO sells gilts and bills just to finance the deficit? Not quite. During the year some gilts and bills will mature and the Government will have to pay the original loan back. The DMO will often need to issue more gilts and bills to pay back these loans.

This means that the stock of debt changes in two ways: the Government’s new borrowing is added, and old maturing debt is rolled over.

Even before the coronavirus outbreak, the UK Government planned to borrow over £160 billion this year: £60 billion to finance the difference between its annual spending and tax receipts and nearly £100 billion to pay back previous debt.

More must now be raised to deal with the costs of coronavirus. The DMO will hold more auctions than previously planned in April 2020. The auctions will aim to raise £45 billion largely through the sale of gilts at various maturities. According to the Institute for Fiscal Studies, £45 billion is more than was raised during any month of the 2007-2009 financial crisis.

Since 2009 the Bank of England has become a large holder of debt – by September 2019 it held 23% of the value. The Bank of England has been purchasing gilts as part of its quantitative easing program which aimed to provide a boost to the economy following the 2007-2009 financial crisis.

The Bank is returning to this approach in response to the coronavirus. It’s expanding its quantitative easing program by around £200 billion (taking the total value of assets it can own to £645 billion). Most of the £200 billion will be spent on Government gilts, which are being bought from investors. The Bank is not buying gilts directly from the DMO. The Bank will then hold over 30% of Government gilts and bills.

What interest does Government pay on its debt?

The Government pays different rates of interest depending on, amongst other things, the type of debt, it’s maturity, and the rate at which markets were willing to lend to it when the auction happened.

he Bank of England’s gilt purchases mean debt interest costs are lower than they would otherwise have been. The effective interest rate paid on this debt is the Bank’s main interest rate – known as Bank Rate – which is lower than the interest rate due on the gilts. Box 1 of the Library briefing Coronavirus: Effect on the economy and public finances explains further.

Steps taken recently by the Bank of England support lower debt interest costs. The £200 billion of Government gilts being purchased by the Bank will effectively be refinanced at the lower Bank Rate. The Bank’s decision to cut Bank Rate to 0.1% (from 0.75%), immediately lowers the effective interest the Government pays on gilts held by the Bank.

Isn’t it currently cheap for the Government to borrow?

Going into the coronavirus outbreak, markets were willing to lend to the Government at historically low rates. The Government was set to take advantage of the low rates and borrow for investment spending.


Rather than borrowing from banks, the government typically borrows from the ‘market’ – primarily pension funds and insurance companies. These companies lend money to the government by buying the bonds that the government issues for this purpose.

Many companies favor investing money in government bonds due to the lack of risk involved: the UK government has never defaulted on its debt obligations and is unlikely to in the future, primarily because it is able to collect money from the public via taxation.

The market in government debt also tends to be stable and liquid, and offers an interest rate in excess of that which is available on other riskless investments (i.e. physical cash).


In most cases the process of government borrowing does not create any new money. While most individuals and businesses accept bank deposits in payment, the UK government does not; they require that the purchasers of new bonds ‘settle’ the transaction by transferring central bank reserves

(see The Three Types of Money) into a government-owned account at the Bank of England. This means that new money is not created in the process of government borrowing.

For example, let’s say a pension fund holds an account at MegaBank and wishes to buy £1 million in government bonds. The fund asks MegaBank, which is one of the Gilt-Edged Market Makers (a bank authorized to deal directly with the government in the purchase of new bonds), to buy £1 million of new government bonds.

MegaBank decreases the pension fund’s account by £1 million and then purchases the bonds on behalf of the pension fund. To settle its transaction with the government, it transfers £1 million of reserves to the government’s account at the Bank of England. The balance of MegaBank’s account at the Bank of England will drop by £1 million.

The government now has £1 million of central bank reserves in its account at the Bank of England, which can be used to make payments. It has borrowed the money without any additional deposits being created.

To spend the money it could now transfer the reserves to Regal Bank where an NHS hospital holds an account. Regal bank would then receive £1 million of central bank reserves, and could increase the account balance of the hospital by £1 million.

So through a rather convoluted process, £1 million of bank-created bank deposits have been taken from pension fund contributors and passed to an NHS hospital. No additional money has been created; only pre-existing deposits have been moved from one place to another. Because the majority of government borrowing is done in this way it does not constitute a monetary stimulus to the economy.

(The exception to this rule is with Private Finance Initiatives, where the government borrows directly from banks. In this case, so long as the government accepts bank deposits rather than requiring a payment into its account at the Bank of England, then banks create the money that the government borrows via Private Finance Initiatives).


The debt is currently higher (in nominal terms) than it’s ever been before. While the government talks about reducing the deficit, the reality is that the total national debt will keep growing. Even if it stops the debt growing, taxpayers will continue paying around £120 million a day in interest on the national debt.

It is very unlikely that the government will be able to reduce debt in the current system. To understand why, consider what would need to happen for the debt to be paid down. First, the government would need to start paying the annual interest on the national debt each year out of tax revenue, rather than simply borrowing the money to pay it.

Interest payments totaled £43bn for 2012, so if the government wanted to reduce the debt it would have to find an additional £43bn in taxes, which would require, for example, raising VAT (sales tax) to roughly 30% (from its current level of 20%).

In addition, in the five years before the banking crisis, the government spent an average of 10.6% more than it received in taxes every year. So even after the £43bn interest on the national debt is paid, to run a ‘balanced budget’ right now, it would need to raise an extra £22bn in taxes (to cover the 10.6% shortfall), or cut public services by £22bn – equivalent to shutting down a fifth of the National Health Service.

So far in this example, the government has raised VAT by 30% and cut £22bn of public services and has still only managed to stop the debt growing. In order to actually reduce the debt, it needs to raise taxes even further, or reduce public spending even more.

If the government decided that it wanted to pay off £30bn of national debt every single year, then it would need to raise another extra £30bn in taxes: equivalent to doubling council tax. Even at this level, it would take 30 years to pay down the national debt, assuming tax revenue is unaffected by these changes.

Of course, increasing taxes by such large amounts is likely to lead to a recession and even a depression: businesses will pass on the costs of higher taxes to their consumers, with the increase in prices likely to lower demand for goods and services.

Likewise, faced with higher taxes, individuals will have lower levels of disposable income, and, independent of the increase in prices this will negatively affect demand.

Both factors will feed through to lower sales and therefore lower sales taxes, forcing the government to further increase taxes to hit its debt reduction target. Lower demand for goods and services will also lead to businesses cutting employment, lowering the government’s income from employment taxes.

Higher levels of unemployment will also increase the government’s spending on unemployment benefits, which will have to be funded through further borrowing, again preventing the government from hitting its targets.

Alternatively, the government could cut its spending. However, this is likely to have similar effects to increasing taxes. During recessions, people tend to cut their spending – if the government cuts its spending at the same time the result can be a catastrophic drop in demand.

This of course lowers output and therefore the tax take. Indeed, in a paper looking at eight episodes of fiscal consolidations (i.e. cuts in government spending), Chick and Pettifor (2010) find that:

“The empirical evidence runs exactly counter to conventional thinking. Fiscal consolidations have not improved the public finances. This is true of all episodes examined, except at the end of the consolidation after World War II, where the action was taken to bolster private demand in parallel to public retrenchment.”

As they point out this runs contrary to mainstream thinking, where recessions are thought to be, at least in the long-term, self-correcting. The presumption is that eventually, the fall in demand will lead to lower prices, at which point demand increases (as the fall in prices increases relative wealth), which increases demand (the Pigou-Pantinkin effect).

However, as was discussed in Chapter 9, when money is created with a corresponding debt, a fall in prices leads to an increase in the real value of debt, thus the negative effect on the real value of debt offsets the positive effects on real wealth.

hus lowering spending/increasing taxes is likely to lead to a fall in tax revenues, requiring even further tax increases/spending cuts and so on. In fact, in this situation, a debt-deflation scenario is far more likely if the population is highly indebted, to begin with.


On the surface, paying off government debt may be beneficial because lower government debt frees up government revenue for core services. It is argued that high levels of government debt may also be problematic in the long run because:

Government bonds compete with private sector investments for funds, so government borrowing diverts money away from private sector investments and increases the rate of interest the private sector pays to attract investment.

Individuals may start saving more (and so spending less) in expectation of an increase in future taxes (to pay off the debt). (This is known as Ricardian Equivalence).

Because of the potential for adverse effects to long term interest rates and the exchange rate.

There is also the danger that excessive government debt can lead to a sovereign debt crisis, as seen in Greece and other Eurozone countries. However, for countries that retain control of their currencies (i.e. those that have central banks that are able to print currency, such as the UK, the US, Japan, but crucially not the Eurozone countries) defaulting on debt is only one of two options,

as the country could simply print currency to pay off its debts. Of course, if this printing of currency caused significant inflation it would reduce the real value of the debt and represent a form of hidden default, in that the holders of the debt would not be repaid as much, in real terms, as they initially invested.

However, it is important to also recognize the positive effects that come from having at least some national debt:

First, as mentioned previously, the debt gives the private sector a safe asset in which it can invest. This strengthens private sector balance sheets, increasing their robustness in the face of downturns and negative shocks (because bond prices don’t fluctuate as severely as stock prices).

Second, it allows a degree of certainty for institutional investors looking for long term returns (such as pension funds with older beneficiaries, who need security over capital gains).

Third, it allows the private sector (excluding the government), in aggregate to hold a positive balance of wealth (see for example Godley and Lavoie (2012)).

Fourth, it is misleading to think of the national debt in the same way as we think about private debts. The major holders of the national debt are UK investors: mainly pension funds and insurance companies.

Thus, it is in many senses a debt we owe to ourselves (albeit it one owed by current taxpayers to current holders of the debt, which can create an inter-generational transfer of wealth). That said, approximately 40% of the national debt is owed to foreign investors (also pension funds and insurance companies).

In addition, it is important to remember that the nominal value of the debt is not actually important; it is the level of debt (and its maturity) relative to the earning capacity of the economy that is the important figure.

For example, an individual with no income and no assets may consider a debt of £10,000 impossible to repay, yet an individual that earns £1 million a year would consider the same debt an inconsequential sum.

Broadly speaking, the ‘income’ of the nation can be represented by GDP (Gross Domestic Product). The chart below shows the national debt as a percentage of the UK’s GDP:

This brings into context the comments made earlier about the government never really paying off its debt. Instead of paying off the debt by actually reducing its nominal value, the debt tends to be reduced over time in terms of its burden. Rather than decrease the nominal amount of the debt, the earning ability of the economy (GDP) is increased.

Unsurprisingly the national debt to GDP ratio tends to shoot up during wars – such as World War I (from £650m in 1914 to £7.4bn in 1919) and World War II (from £7.1bn in 1939 to £24.7bn in 1949). It also shot up significantly in 2008 onwards, as the tax take plummeted due to the recession and spending (for example on unemployment benefits) increased.

(The borrowing to bail out banks is not included in the main national debt figures.) It is pertinent to note here that despite the financial crisis, public debt is actually at a relatively low level (albeit at its highest level historically in the absence of a World War).

In addition, we must be clear that the largest part of the recent increase in public debt came about not due to too much spending, but rather as a result of the government’s reaction to the financial crisis.

This brings us to the crux of the argument. The first half of this book [Modernising Money] was largely concerned with the effect of the banking sector on the economy and society as a whole. The excessive creation of private (i.e. household and business) debt was shown to be a major cause of boom-bust cycles, financial crises, recessions, etc.

As can be seen from the chart below, the level of private debt far exceeds the level of public debt, and as such, this should be the focus of debt reduction efforts

As well as looking at absolute values, the cost of debt (i.e. the interest rate on the debt) should also be considered. In this context, the overall interest rate on the national debt between 2000 and 2012 worked out at around 5.6% per annum (Webb & Bardens, 2012).

In contrast, the interest rate for household debt ranges between 6% and above for mortgages, right up to 17% on credit cards and up to 29% on store cards.

Overall, the average interest rate is undoubtedly higher for households than it is for the government. For these reasons, the government should focus on enabling the public to reduce its debts.


Photos by