According to a recent poll, half of the public believe there is no need to cut spending to reduce public debt. Today’s figures from the Bank of England suggest they might be right. They show that individuals borrowed money in August (pdf), suggesting that July’s repayment was a one-off, and that non-financial firms have begun to borrow from banks after paying back money for months.
This matters for the public finances for a simple reason - across the whole economy (which includes foreigners), net borrowing must equal net lending by definition. So if firms and households borrow more, government will borrow less.
My chart, taken from table I of today’s GDP data, shows this. It shows that there is an almost perfect negative correlation (minus 0.93, R-squared = 86.2%) between private sector net borrowing and government net borrowing*; these numbers refer to Q2, so take no account of today‘s data.
This tells us that government borrowing is largely a result of the credit crunch. In forcing the private sector to become a big net lender, this has compelled government to borrow a lot.
This means that if the private sector starts borrowing again - as today‘s figures suggest they are - government borrowing will fall almost one-for-one. If so, the public finances might improve quicker than expected in which case the need for spending cuts will be less.
You might object that this is too optimistic. The cliché “you can’t read too much into one month’s figures” is a cliché precisely because it’s true. We are a long way from the normal level of private borrowing required to get government borrowing down to its usual levels. And in fact today’s numbers show that financial companies are repaying debt.
These objections are valid. But they hardly produce an urgent case for cutting government spending. Doing this at a time when the private sector is unable or unwilling to borrow and spend is a recipe for depressing demand.
The message is simple. Looking at government borrowing properly - that is, as the counterpart of private lending - suggests either that spending cuts might be unnecessary, or that they could be downright damaging.
This isn’t to say that spending cuts will be unnecessary in all circumstances. We might need them to pacify the bond market. But because gilt yields are so low now - even in the face of the worst news about public borrowing - this is only a plan B.
* The correlation is not minus one because I’ve ignored foreigners’ net lending. But the fact that the correlation is so strong shows that this omission makes little difference to my story.
This matters for the public finances for a simple reason - across the whole economy (which includes foreigners), net borrowing must equal net lending by definition. So if firms and households borrow more, government will borrow less.
My chart, taken from table I of today’s GDP data, shows this. It shows that there is an almost perfect negative correlation (minus 0.93, R-squared = 86.2%) between private sector net borrowing and government net borrowing*; these numbers refer to Q2, so take no account of today‘s data.
This tells us that government borrowing is largely a result of the credit crunch. In forcing the private sector to become a big net lender, this has compelled government to borrow a lot.
This means that if the private sector starts borrowing again - as today‘s figures suggest they are - government borrowing will fall almost one-for-one. If so, the public finances might improve quicker than expected in which case the need for spending cuts will be less.
You might object that this is too optimistic. The cliché “you can’t read too much into one month’s figures” is a cliché precisely because it’s true. We are a long way from the normal level of private borrowing required to get government borrowing down to its usual levels. And in fact today’s numbers show that financial companies are repaying debt.
These objections are valid. But they hardly produce an urgent case for cutting government spending. Doing this at a time when the private sector is unable or unwilling to borrow and spend is a recipe for depressing demand.
The message is simple. Looking at government borrowing properly - that is, as the counterpart of private lending - suggests either that spending cuts might be unnecessary, or that they could be downright damaging.
This isn’t to say that spending cuts will be unnecessary in all circumstances. We might need them to pacify the bond market. But because gilt yields are so low now - even in the face of the worst news about public borrowing - this is only a plan B.
* The correlation is not minus one because I’ve ignored foreigners’ net lending. But the fact that the correlation is so strong shows that this omission makes little difference to my story.
Surely if the private sector is starting to borrow again that improves the case for cuts in discretionary spending now, if you think the structural public sector deficit is too large and needs to be reduced at some point. If the time to cut public spending isn't when private spending is picking up, when is it?
The Tories were knuckle-headed to be calling for immediate cuts when private sector demand was low. But don't these data strengthen their position now?
Posted by: chrisg | September 29, 2009 at 03:36 PM
Chris, as his is nearly an identity does it 'tell' us that an increase in private sector lending has compelled the government to borrow more - or might there be a possibility (not large in this instance because of what else we know) that an increase in government borrowing has compelled the private sector to lend more.
Also, theoretically couldn't a large increase in private sector lending have led to a large outflow of capital abroad? Would this have happened if the government had cut spending and raises taxes - I'm not why. In that scenario I'd have though a decline in GDP bringing private saving and government deficits back into line would be more likely.
Posted by: Matthew | September 29, 2009 at 05:56 PM
@ Chrisg - I forgot to distinguish between two different arguments for cutting public spending. The argument we hear is that cuts are necessary to reduce the big deficit. This is silly, at least whilst gilt yields are low.
There is, though, another argument - that as the economy recovers and private sector borrowing resumes, fiscal policy should be tightened counter-cyclically. I've no problem with this - except that we are a few years away from such a stage.
@ Matthew - Yes, increased government borrowing can cause higher private saving. This is what happens under an orthodox Keynesian expansion; a portion of the higher incomes are saved. But as you say, this is not the main story now.
And yes, private lending can lead to capital outflows. This has happened in the last 12 months, because the same credit crunch that caused higher private lending also caused a collapse in cross-border banking activity which hit the UK hard, though not as hard as Iceland!
However, these outflows have abated recently. And it's not at all obvious that tighter fiscal policy would have made a difference; overseas banks withdrew money from UK banks because they needed the cash themselves, not because they were worried by UK government borrowing.
Posted by: chris | September 29, 2009 at 06:24 PM
What is happening to the overseas deficit? I don't have the figures but I guess that it is not increasing as the counter party to the public deficit as happened in the 1970s. This again is an argument for avoiding drastic deficit reduction now.
What is the breakdown between personal and corporate net lending? Again my guess is that it is the corporate sector that is the big generator of the increase in the surplus
The risk is surely though that government is now just too big and that the private sector will not choose to spend more unless it is incentivised to do so. Or is this too ideological.
Posted by: Grumpy Optimist | September 30, 2009 at 11:26 PM
How this ultimately turns out is going to be quite interesting.
Posted by: Chris Neufeld | October 05, 2009 at 05:03 AM
nice post...
i really like this...
thnks...
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Posted by: Sarah Danes | October 05, 2009 at 11:19 AM
Whenever you consider any lending, particularly the substantial amounts required for a mortgage secured against your home, you should make sure you check thoroughly what the payments will be like before committing to anything.
Posted by: remortgage repayments | July 02, 2010 at 07:41 AM
Maybe if we raised the pay wages and lowered the cost of living a little bit we could minimize private lending, and personal, business and over all debt. If we made enough that we didn't need the loans to get by then the problem could be solved.
Posted by: Shyloh J | February 04, 2011 at 08:36 PM