In the last three months, governments around the world have been spending huge sums of money on packages to reduce the economic devastation being caused by Covid-19.
So far, the global response has amounted to over $7 trillion, and many of you may be wondering where this money comes from. In the UK for example, they have announced billions of pounds worth of emergency funding to pay people’s wages and loan businesses of all sizes. Surely, they don’t have unlimited amounts of money to spend though? The answer to that is no, so the question is, where does it come from?
Governments who are strapped for cash, are not that different from ordinary people. When they need more money, they have two main options: cut costs or borrow! And the latter is exactly what the UK government is doing to fund their big spending during this crisis.
They are planning to borrow over £200 billion to fund their increase in public spending. A move which is expected to increase the UK’s fiscal deficit to £273 billion this year.
But how do governments borrow money? Who do they borrow from?
Governments will borrow from banks, pension funds, and investors, by selling them government bonds, and in return they receive regular interest payments.
Unlike individuals, governments have more options than just a few banks to borrow money from. This is because banks and investors do not feel like they are loaning out money. On the contrary, lending money to the government is viewed by the private sector as a very safe investment.
Although borrowing may seem like an easy option for a government, especially in times of crisis, a large amount of public debt can be catastrophic for a country’s economy. Just like when an individual is in debt, the more the government owes the more interest they have to pay. The more interest they have to pay comes with a large opportunity cost, meaning that there will be less funds for public spending on services such as education and healthcare.
What is clear from the last few months of radical economic policy across the world, is that governments have been forced to think in the short-term as they try to deal with this crisis, with all long-term effects largely ignored, and to be dealt with when the time comes.
THINK LIKE AN ECONOMIST!
Q1. What is meant by the term fiscal deficit?
Q2. Explain how a government borrows money.
Q3. Explain the impact that increased government borrowing will have on the fiscal balance for a country.
Q4. Discuss the advantages and disadvantages of a government increasing their borrowing.
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