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Why running a budget deficit can reduce the national debt

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YESTERDAY, at an event hosted by the Resolution Foundation, a think-tank, the organisation’s chief economist, Matt Whittaker, said something that made a few people sit up. He remarked that it would be simultaneously possible to run a budget deficit (ie, where government spending exceeds taxation) and reduce the burden of government debt at the same time. Now, to British ears this sounds impossible. Running a budget surplus, as the chancellor of the exchequer, George Osborne, is desperate to do (on the wisdom of that,see here) is often elided with paying down the national debt, which currently stands at around 80% of GDP (bailed-out banks notwithstanding).

And in a way, that does make sense. If the government gets more in taxes than it spends, it will have money left over to repay debt. And given the government does not have to borrow more money, it does not need to issue any more debt. So eventually, the stock of debt will fall.

However, the stock of debt doesn’t really matter, for all intents and purposes. What doesmatter is the size of the debt relative to the size of the economy, and the pool of taxpayers’ incomes from which revenues are drawn. And it is perfectly possible to reduce the relative size of debt while simultaneously running a budget deficit. The graph below, which starts in 1947 and finishes in 2013, shows two things: the blue line shows the debt-to-GDP ratio and the grey lines show the years when Britain was running a budget deficit. As you can see, even though there were many deficits in the postwar period, debt grow far more slowly than the economy, so the debt-to-GDP ratio fell dramatically.

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This is worth remembering as we near the autumn statement, a mini-budget which Mr Osborne will deliver on November 25th. A budget deficit need not imperil the public finances.

PatrickJara
PatrickJara
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