Across the western world, governments are struggling with high public debt. After much melodrama the US congress increased the amount of money the US government can borrow. In the UK net public sector debt has increased from 37.5% of GDP in 2007 to 61% of GDP in 2011. The coalition has set itself the target of eliminating the public sector deficit over the next four years. They claim that there is no alternative to cutting government spending, and unless government spending is reduced, the UK may be unable to afford to pay its debts and may risk default on its debts.
These claims are false. It remarkably simple to check whether a country, a company or individual is likely to default. When borrowers’ likelihood of default increases the interest rate they are forced to pay on their debt goes up. For example, Greece is currently teetering on the edge of bankruptcy, and currently it must pay 14% on its government debt. So what has happened to the interest rate on British government debt?
Unlike Greece, the real interest rate on UK government debt has fallen from around 2% at the start of the financial crisis in the summer of 2007 to around 0.5% currently. This suggests there has never been any risk of the UK government defaulting. If anything these interest rates suggest the risk of default has consistently fallen since the credit crunch. There’s little evidence that the real rate has declined as a result of the coalition’s planned cuts. US and UK stock markets have fallen, and the price of government bonds have increased, this suggests that pessimism about future growth has increased but there few concerns about UK or US solvency.
Therefore, any decision to reduce the government spending has not been taken because it is not possible for the UK to borrow. Quite the reverse: the real cost of each pound of UK government borrowing has fallen by three quarters. This suggests that decisions about the scope and speed of changes to government spending have been out of choice rather than necessity.
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