11.6Summary

All countries have a public debt but there have been frequent changes of attitude

towards the public debt and the public sector nancial decits, which add to them.

These attitudes have been reected in alterations in denitions and the ways in which

information on the public nances have been presented. The most recent changes

in the UK have seen the public sector borrowing requirement (PSBR) replaced by

the public sector net cash requirement (PSNCR) and much greater emphasis placed

on the public sector current balance than previously. Other calculations such as the

PSNCR/GDP ratio, the real value of the PSNCR or the income-adjusted PSNCR can

be made to help in interpreting the economic signicance of public sector decits.

As long as the bonds sold by government to nance the public debt are willingly held,

the debt can go on increasing without causing economic problems. However, in

recent years the public debt has been seen increasingly as a burden on the economy

and much attention has been paid to the ‘sustainability’ of the public nances. This

has had a strong impact on market attitudes towards highly indebted countries and

market responses have in turn inuenced government policies.

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Chapter 11 • Government borrowing and nancial markets

Much of the debate surrounding the view that high public sector decits are

undesirable concerns the nancing of the PSNCR. It has been widely accepted that

an increase in the PSNCR either pushes up interest rates (if the decit is nanced

by sales to the non-bank private sector) or increases the rate of ination (if the

decit is residually nanced). There are many dubious assumptions underlying this

proposition. There are many circumstances in which more government securities

can be sold without residual nancing and without causing interest rates to rise. For

example, the authorities may be able to sell more bonds at existing interest rates

through innovative marketing techniques or by improving the non-price charac-

teristics of the bonds. Further, the link between the rate of growth in the money

supply and the rate of ination is far from proven. Nonetheless, it remains true

that if it is believed in nancial markets that high public sector decits and a high

public debt are undesirable, governments have to pay close attention to these views.

One way in which nancial markets inuence governments is through the ratings

given to them by international credit-rating agencies.

Although the existence of the public debt poses problems for governments, it

also allows them to engage in open market operations. On the other hand, govern-

ments must carefully manage their public debt to avoid the possibility of too high

a proportion of the debt maturing at the same time. Debt management can have an

impact on an economy’s interest rate structure.

Questions for discussion

1	Why have governments frequently had difculty in controlling the size of the PSNCR?

2	Consider the various ways in which the gures for the PSNCR may be interpreted. Why are so many interpretations possible?

3	Explain the theoretical relationship between the PSNCR, the rate of growth of the money stock and interest rates. Why is this relationship unlikely to hold in practice?

4	What was the economic signicance of the changes introduced into the gilts market and into National Savings in the 1970s and 1980s?

5	How does the existence of the public debt complicate the funding of the PSNCR?
6	Who are the international credit-rating agencies? Why do they exist?
7	The public debt/GDP ratio is described in the text as ‘rather odd’. In what ways is it odd?

8	Find examples in the nancial press of: (a)government scal policy decisions inuencing nancial markets; and (b)the attitudes of nancial markets towards public sector decits and/or public debt inuencing economic policy.

9	Explain the differences between each of the following pairs: (a)the PSNCR and the public sector current balance; (b)the PSNCR and the PSBR; (c)the public sector decit and the public debt; (d)the public debt and the national debt.

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	Answers to exercise
Further reading

P Howells and K Bain, The Economics of Money, Banking and Finance: A European Text

(Harlow: Pearson Education, 3e, 2005) ch. 16

J Wormell, The Gilt-Edge Market (London: Allen and Unwin, 1985)

Bank of England at http://www.bankofengland.co.uk

Debt Management Ofce at http://www.dmo.gov.uk

Answers to exercise

11.1

(a)Because they believe that the ECB or other euro-area governments will rescue any member country in danger of defaulting, contrary to the statements in the Maastricht treaty and later.(b)0.24 per cent. (c)The average size of bond issues increased dramatically. (d)No. It removed foreign exchange risk among euro-area countries, but the risk of the euro changing in value against sterling, the US dollar, the yen and other currencies remained.(e)Because Germany has a high credit rating and its bonds are very liquid. (f)For the bonds of a small country to become as liquid as German bonds, it would have to issue many more bonds than would be justied by its size. This would imply a high public debt/GDP ratio.

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CHAPTER12

Financial market failure and

nancial crises

Objectives

What you will learn in this chapter:

lArguments concerning the ability of small rms to borrow

lThe nature and role of venture capital trusts (VCTs)

lQuestions concerning UK lending overseas and the debate over ‘short-termism’

lThe meaning of nancial exclusion and the problems for the nancially excluded

lIssues in the debate over low long-term saving and the pension problem

lConcerns about household indebtedness

lThe tendency in nancial markets to bubbles and crashes

lThe nancial implications of frauds and scandals in non-nancial companies

We have seen throughout this book that the efciency of a modern economy

is greatly enhanced by the development of the nancial system. It is also true,

however, that weaknesses in nancial markets can be very costly to individuals,

rms and the economy as a whole. As with all other markets, nancial markets are

subject to market failure – interferences with the market ideal of perfect competi-

tion that might arise, for example, from the presence of elements of monopoly or

oligopoly, the presence of externalities, the lack of information in general or the

existence of asymmetric information. In this chapter, we shall consider problems

deriving from the operation of nancial institutions and markets. We shall begin

by looking at problems relating to the ability of rms and individuals to borrow

through the nancial system. We shall then consider issues concerning the level

of saving in the economy. The chapter continues with sections on complaints about

the apparent irrationality and ‘exuberance’ of nancial markets and the possibility

of nancial market crashes, and on the frequency of nancial scandals and fraudul-

ent behaviour in nancial markets. It concludes by looking at some international

issues.

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