The Public Sector Net Cash Requirement (PSNCR)

Many of you will know this as the PSBR (Public Sector Borrowing Requirement). The name has now been changed and you need to be aware of that fact. This Learn-It brings the topic of 'Taxation and government spending' together very well. If the government finds that it needs to spend more than it has collected in tax revenue (as it often does!), then it must borrow. Annually, the amount borrowed is called the PSNCR.

The PSNCR

More formally, this is the amount that the government sector needs to borrow, over and above the tax revenue collected, to finance planned government spending in a given year. It includes borrowing by public corporations and local government as well as central government. Note that the PSNCR is often referred to as the budget deficit. This should not be confused with trade deficit, which is the deficit on the 'trade in goods' section of the current account of the balance of payments.

The National Debt

This is the total amount owed by the government. It is the sum of all PSNCRs ever borrowed. Its current value is roughly £400 billion! This may sound like a lot of money, but it is only roughly half of GDP (which is currently around £800 billion a year). Remember, the UK earns £800 billion (and rising in future years) every year. The government's debt position compares quite well some individuals' finances. When a young couple buy their first house with a mortgage, they often borrow up to two and a half times their joint annual income. This makes the government's debt look quite meagre.

Public Sector Debt Repayment (PRDR)

Occasionally, the government does end the year with money left over after all their government spending has been completed. In this case, they are, by definition, paying back some of the huge National Debt that they have accrued. In recent years, this has only happened in 1969-70 and 1988-90 (the boom years), although we are currently in a position where the government is able to pay off some debt.

Thatcher was very keen on reducing government spending and, therefore, the PSNCR. She felt that high PSNCRs were inflationary. To understand why a PSNCR might be inflationary, you need to understand from whom the government borrows.

Although governments do sometimes borrow from a third party (from abroad) in the same way as an individual might borrow from a bank, most of the borrowing of the UK government is in the form of selling bonds and Treasury bills to individuals and pension institutions. In other words, the UK government is borrowing from its own citizens.

Government borrowing is only inflationary if the money supply increases as a result. Developed countries gave up printing money to finance borrowing (which obviously increases the money supply) years ago. As long as selling these bonds and bills to the non-banking sector finances the borrowing, then the effect on the money supply will be neutral. This is because every £1 borrowed and spent by the government (an injection into the economy) will be matched by £1 less spending by the individual who bought the bond or bill. For the individual concerned, this is a form of saving, which is a leakage from the economy.

It is dangerous to sell bonds and bills to the banking sector because they can be treated as relatively liquid assets, so the bank can lend money against them, thus increasing the money supply.

A developed country will only have problems financing their PSNCR, therefore, if they cannot attract enough customers to buy the required bonds and bills. Even at the height of the recession in the early 90s, when the UK government borrowed £50 billion in one year (£1 billion a week!), they still managed to find buyers of the required bonds and bills. Of course, interest rates may have to be increased to attract the buyers (the interest is the money earned while in possession of a bond or bill), which is not particularly desirable in the middle of a recession, but the UK no longer has to resort to printing money, unlike Russia, for example, in times of trouble.

Of course, the UK government has credibility. It is very unlikely that they will not be able to pay the borrowed money back to the bond and bill holders. Developing countries with unsophisticated capital markets often have a lot of trouble financing their debt in the same way. They do not really want to resort to printing money, so their last resort is to ask for help from the International Monetary Fund (IMF). The IMF will lend money on condition that the borrowing country adheres to a strict programme of cuts in government spending.

So, in conclusion, UK government borrowing is not really inflationary in itself, as long as the government as careful with their sale of bonds and bills. Of course, the resulting spending of the borrowed money may be inflationary if the economy is near to its full employment level of real national income. If the government spending pushes aggregate demand to a level above the productive potential of the economy then the price level will have to rise (see the topic called 'Aggregate demand and aggregate supply' for details).

In the section above, we discussed the likelihood of borrowing being inflationary, and the possibility of it leading to higher interest rates. Here are some of the other arguments as to whether government borrowing is 'OK'.

Why might government borrowing be 'OK'?

1. What is it spent on? Economists often feel that government borrowing is more acceptable if it is spent on capital goods rather than current spending. If the borrowed money is spent on machines, or the infrastructure (roads and rail) or education (improving workers productivity), then the productive potential of the economy will increase and future increased incomes will more than make up for the money borrowed and the interest on the debt. The current Labour government has committed itself to the 'golden rule'. This means that, over the economic cycle, they will only borrow money to invest. Any current expenditure has to be funded from current tax revenues. In theory, this should stop any inflationary rises in aggregate demand through government current expenditure.
2. Demand management. As was discussed in the topic called 'Aggregate demand and aggregate supply', Keynesian economists believe in the importance of managing the level of aggregate demand in the economy. At times of recession, when there is a lot of spare capacity in the economy, it is felt that the government must step in and force the level of demand up, usually through government spending but also with tax cuts. During recessions, tax revenues from income are likely to be relatively low, so the only way that the government can spend the required money is to borrow it.
3. Automatic stabilisers. During recessions, government borrowing inevitably rises because tax revenues are down and spending on, for example, unemployment benefit is likely to be higher. This is a cyclical increase in borrowing about which the government can do nothing. These lower tax revenues (which leave taxpayers with more money relative to their gross income) and higher spending on benefits (which should help boost spending in the economy) act as automatic stabilisers that, hopefully, stop the swings in the economic cycle from being too large.

Why might excessive government borrowing be a problem?

1. Problems with inflation. This was outlined in the section above. Remember that it is not just the problem of the way the borrowing is financed (bills and bonds or printing money?). More importantly nowadays, it is the resulting excessive spending that may push aggregate demand beyond the productive capacity of the economy.
2. Crowding out. Increases in government borrowing might lead to increases in interest rates. Whilst the extra government spending will probably focus on the non-market economy, the higher interest rates may 'crowd out' the (potentially) more efficient private sector investment in the market. Some would say that government spending on, say, improved education is as worthwhile as any private sector investment. Not all government spending is quite so productive, though. Also, those who believe in the supremacy of the market argue that private sector investment is always better because of the existence of the profit motive. This means that resources are directed to their most efficient use. Are governments so careful when they choose where to invest?
3. Credibility. Traditionally, Conservative governments have had a goal of keeping spending, and therefore government borrowing, as low as possible, whereas Labour governments tend to spend more. Consequently, Conservative governments tend to have a better reputation with the 'City' who, at the touch of a few buttons, can cause the £ to drop causing all sorts of trouble. This 'credibility' with the City is seen as very important. There were predictions of a devaluation of the £ and resulting higher interest rates as the Labour Party swept into government in 1997, but they quickly managed to earn some credibility by making the Bank of England independent with a week of entering Office, and keeping a tight rein on government spending as promised. This was a surprise for many experienced observers. The new Labour government have managed to out-Conservative the Conservatives!
4. The burden of debt on future taxpayers. All debt has to be paid off in the end. The recent Labour government has managed to pay off some of the national debt by keeping its spending levels at surprisingly low levels (as a percentage of GDP). Usually, though, increased government debt results in a rise in the future tax burden. The choice of higher taxes or lower real spending (on health and education, for example) is not particularly appetising. Also, in the previous Learn It on taxation, we discussed the disincentive effects of higher taxes on incentives to work.