11.1 The measurement of public decits and debt

Table 11.2Estimates and projections of key UK scal balances

Year	Surplus on	PSNB	PSNBd
				Public sector
	current budget	£ billion	% of GDP	net debt
	£ billion			% of GDP

2004–5a	19.0	39.7	3.0	35
2005–6b	11.4	37.1	2.4	36.7
2006–7c	7	36	1.9	37.9
2007–8c	1	30	1.6	38.4
2008–9c	7	25	1.6	38.5
2009–10c	10	24	1.6	38.6
2010–11c	12	23	1.5	38.6

^aoutturn^bestimate^cprojection^d cyclically adjusted

Source: UK Budget Report 2006 Chapter 2. Available on http://www.hm-treasury.gov.uk

indicators of sustainable public nances in the Maastricht treaty convergence condi-

tions for membership of European Monetary Union and remains central to the Stability

and Growth Pact. Yet again, the second public nances rule of the Labour govern-

ment after 1997 – the sustainable investment rule – made use of the ratio. This rule

stated that net public sector debt as a proportion of GDP should be held at a ‘stable

and prudent’ level over the business cycle. Box 11.2 considers the current attitude of

the UK government towards its public sector decit and debt. Table 11.2 provides

gures for key public sector balances as announced in the UK budget of 2006.

Care needs to be taken with these gures, especially the projections for future years.

These are based on a number of assumptions. Important underlying assumptions

include the projected rate of growth of the world and UK economies. It is usual for

Chancellors of the Exchequer to be optimistic about the future rates of growth of

the economy and hence about projections for taxation revenue and social security

expenditure in future years. It follows that the projections in Table 11.2 are likely to

be revised in the coming years.

Box 11.2

The scal policy of the UK government in 2006

When the Labour government was elected in 1997, the Chancellor of the Exchequer,

Gordon Brown, announced his intention of maintaining sustainable public nances in

order to avoid the ‘boom and bust’ mentality of past British macroeconomic policy. Past

Labour governments had had a reputation for high public expenditure and high public

sector decits. Thus, if the nancial markets had responded to the new government

as in the past, they would have expected higher future ination and interest rates. They

would have sold longer-dated government bonds, lowering their prices and pushing up

the yields on them. The yield curve would have become more steeply upward sloping

at the long end (see section 7.7). Interest rates would have had to increase on newly

issued government debt, increasing the costs of nancing future decits. In his attempt

to avoid this, the Chancellor:

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Chapter 11 • Government borrowing and nancial markets

(a)	made the Bank of England politically independent and gave it control of UK monetary policy, setting it an annual target rate of ination of 2.5 per cent per annum, changed to 2.0 per cent in December 2003;

(b)	set out to persuade the nancial markets that the PSNCR/GDP and public debt/GDP ratios would remain low. To achieve (b), he:

(i)	resolved to keep, in the government’s rst year of ofce, to the public expenditure limits set by the previous government;

(ii)	adopted the two scal rules mentioned in the text – the golden rule of public nances (see section 11.1) and the sustainable investment rule (explained imme- diately above).

Strategy (a) was clearly successful. In 1997/98, gilt yields fell sharply: at the longer

end, they reached their lowest levels since the 1960s. Medium and short yields also fell

duringthe year.

Early budgets also conrmed the determination of the Chancellor to control public

sector borrowing. The 1999 budget forecast a surplus (debt repayment) of £1bn and low

gures for the PSNCR for the subsequent six years – less than 1 per cent of GDP in each

case. The public sector current balance was forecast to be in surplus for each of the

following ve years.

In recent years, however, government policy has moved partly in the direction of

increasing budget decits in order to increase public expenditure on run-down areas

of the public sector, with public expenditure planned particularly on the NHS and in

education. This, together with the slowdown of the UK economy, has led again, from

2002–03 onwards, to positive public sector net borrowing gures, despite some increases

in tax rates, notably National Insurance contributions. As a result, public sector net debt

grew from 30.2 per cent of GDP in 2001–02 to 35 per cent in 2004–05 and is projected

to grow to 38.6 per cent in 2009–10. This remains low by world and UK standards. In

the UK, net debt fell from 53.9 per cent of GDP in 1975–76 to 26.2 per cent in 1990–91.

It rose again to 43.7 per cent in 1996–97 before falling again.

In his 2006 Budget statement, the Chancellor remained condent that he would meet

his own rules for scal prudence – the golden rule and the rule for sustainable public

debt. However, note should be taken of the comments on Table 11.2. Doubts have also

been expressed about an alternative method that has been used by the Labour govern-

ment and by the Conservative government before it to allow increased government

investment without adding to public sector debt and endangering the Chancellor’s rules.

This is known as the Private Finance Initiative (PFI). This is dealt with in Box 11.3.

Box 11.3The private nance initiative (PFI) and the public nances

The Private Finance Initiative (PFI) was rst announced by the Conservative government

in the autumn of 1992. The Labour Party, then in opposition, objected to the policy but

accepted it and expanded its use after it became the government in 1997. The aim

was to allow investment in major public sector projects without adding to government

borrowing through the involvement of the private sector. Under a PFI contract, a private

consortium, usually involving a large construction rm and a bank, design, build, and in

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