Why government borrowing has fallen

Phillip Hammond said yesterday that the public finances “continue to improve” “thanks to the difficult decisions we have taken in the last nine years.” This is not quite correct.

To see why, imagine that people and companies were to save a constant fraction of their disposable income, come what may, in the face of fiscal austerity. As their incomes fall in the face of that austerity their spending would therefore fall one-for-one. That would further reduce aggregate demand which would in turn cut the government’s tax receipts and add to government borrowing. We’d then suffer a severe paradox of thrift, in which everybody’s efforts to save more would lead to weaker incomes for all and hence to lower savings.

This tells us that governments can borrow less if and only if somebody else borrows more or saves less. This is in fact trivially true. Every pound borrowed is a pound lent. One person’s net borrowing can therefore fall if and only if somebody else’s net lending falls.

My chart shows the point for the four main sectors of the economy. It shows that government borrowing has steadily declined since 2009. The counterpart to this, however, has been a sharp swing in household net lending. For example, in the 12 months to September 2010 they were net lenders of 4.8 per cent of GDP: they were saving a lot and borrowing little. In the 12 months to September 2018 (the latest period for which we have data) they were net borrowers of 1.3 per cent of GDP. This swing of 6.1 percentage points is by far the biggest counterpart to the 8.2 percentage points fall in government net borrowing. It is mainly due to a decline in the household savings ratio.

We can therefore tell a different story about why government borrowing has increased. It’s because, in response to austerity, households saved less and borrowed more in an attempt to maintain their spending: companies have also borrowed a bit more too. This supported aggregate demand and hence employment and wages – which allowed tax revenues to hold up as spending was squeezed.

In this sense, the government has not cut borrowing. It has only privatized it – shifted it from its own account onto households.

Herein lies the reason why the OBR foresees only a small further reduction in PSNB – from 1.1% of GDP this year to 0.5% by 2023-24. It’s because it foresees no great change in households or corporates net borrowing: see chart 3.28 on page 59 of this pdf.  

My point here is that the public finances are never fully “under control”, despite the claims of many people who should know better. Government borrowing depends upon the actions of the private sector – actions over which policy-makers have only limited control. If the private sector chooses to borrow a lot (as it did at the turn of the century) the government will be a net saver. And if the private sector borrows a lot – as it did after the 2008 crash – government will be a net borrower.

One Big Fact tells us this. It is that official forecasts for government borrowing are usually wrong. Since 2000 the average error (regardless of sign) in forecasts for PSNB made in the spring for the following fiscal year has been 1.1 percentage points of GDP - £24bn in today’s money*. Even excluding 2008-09 (when borrowing was 4.4 percentage points of GDP more than forecast) the average error has been 0.9 percentage points of GDP. Such big errors are inconsistent with borrowing being fully under control: if it were, it’d be perfectly forecastable. But they are consistent with borrowing responding to the private sector’s decisions to save or borrow.

So, Mr Hammond is wrong. The fall in government borrowing is not due to his government’s “difficult decisions” – difficult for other people of course. It is due to a decline in private sector savings.

* Historical forecasts are here. Out-turns are in table PSA5A of this pdf.

Comments

[Andrew J Dodds]

Nitpick:

And if the private sector borrows a lot – as it did after the 2008 crash – government will be a net borrower.

Should probably be

And if the private sector saves a lot – as it did after the 2008 crash – government will be a net borrower.

[Christopher Herbert]

Standard MMT scholarship has accurately predicted this, and many other observations that neoliberals regularly get wrong. Time to cashier the lot.

[Luis Enrique]

(a minor nit, this is a bit confusing: "save a constant fraction" and "everybody’s efforts to save more" the latter would imply trying to save a higher fraction, I think)

And Christopher H, I want to say MMT does not have a monopoly on looking at account identities, but I hesitate because I am not 100% sure the BoE and the OBR and others ensure their forecasts respect them. I would like to think they do. Anyone know for sure?

[Robert Mitchell]

Private sector net financial assets increase far more than government debt. Treasury implicitly guaranteed mortgage-backed securities, but the Fed created new money to cover the insurance guarantees by buying MBS. Government debt was not involved. MMT gets this wrong: private sector profits increase without the government having to run deficits, because the Fed creates new debt-free money to backstop previously-created private sector new net financial assets.

[Staberinde]

Well this is a bit confusing.

If the government can’t control its own borrowing, how can we criticise it for over or underspending? It is constrained by private sector activity which it can neither control nor predict.

If government borrows less for, say, capital investment, this is offset by an increase in private borrowing. Why should the Left care whether it’s the government giving more money to a Carillion or the working poor going to a Wonga?

I think this lets ministers off the hook. No such thing as austerity, it’s just a consequence of an increase in private spending.

[Ted]

One could easily argue that it's actually confidence in the future that drives rising household borrowing, not falling living standards. Your chart illustrates this as saving was HIGHEST in 2010 just after the GFC when everyone was skint and scared about their jobs. So Hammond could argue that Tory 'prudence' has led to confidence, which has led to more household borrowing, which has led to a lower PSBR in a virtuous circle.

[LucB40400468]

A couple remarks:
0/ Reading it as a mainstream Public Finance enthusiast, I read "lower G and gvt borrowing not accompanied by a decrease in output" --- your quote: 'This supported aggregate demand and hence employment and wages – which allowed tax revenues to hold up as spending was squeezed.' --- and I think... Mission accomplished?
1/ Macro and time horizons: are we all comfortable with an AD-centric story and paradox of thrift at a TEN year horizon?
2/ Funny property of private savings offsetting government dissavings. You could call it ricardian!
3/ The government does control expenditure and that is what it should focus on. Debt is a secondary concern.

[Martin]

Government should focus on quality of life over the long term for most citizens. That could not have led to the austerity policies actually adopted since 2008.

[Blissex]

This tells us that governments can borrow less if and only if somebody else borrows more or saves less. This is in fact trivially true. Every pound borrowed is a pound lent.

Oh my: banks can lend pounds that they have not saved, so "saves less" is quite wrong.

«One person’s net borrowing can therefore fall if and only if somebody else’s net lending falls.»

And that "net lending" is right as long as it is not taken as meaning the same as "net saving".

«My chart shows the point for the four main sectors of the economy.»

Looking at those "ex-post" accounting identities for the largely arbitrarily defined "sectors" of the national accounts is basically useless by itself. Often it is more productive to look, when available, at central bank "flow of funds".

Anyhow G Hammond is right that the tory policies of the past decade have produced higher tax receipts and lower deficits, because while a government deficit is very hard to reduce with an austerity policy, the past 10 years have not been austerity.

The main tory policy has been redistribution from poorer to richer via rigged markets. That redistribution has boosted the incomes and wealth of the richer citizens, and with it government tax receipt, and the other tory policy has been to cut government spending on poorer citizens, and both policies have helped cut the deficit.