When government finances are discussed you usually see two figures or charts trotted out. One is the government’s deficit, the amount of money it is borrowing, either as a nominal figure or as a share of national income. The other is the government’s debt, usually, again, either as a nominal figure or as a share of national income.
A government deficit may or may not be a bad thing, it depends on the circumstances. But as a figure itself it doesn’t give you the fullest picture of the sustainability of the government’s finances. If nominal GDP, national income, increases at a faster rate than the nominal debt, debt as a share of national income will fall even if there are deficits. So a chart like Chart 1, showing debt falling to the early 1970s, can coexist with a chart like Chart 2, showing government deficits in the same period.
The important thing for government fiscal sustainability, it seems to me, is the relative speed with which two magnitudes grow; nominal GDP and nominal government debt. If the percentage growth rate of nominal debt is higher than the percentage growth rate of nominal GDP, government debt will be increasing as a share of GDP and government finances are unsustainable.
Compare Chart 3 with Chart 2.
This shows the percentage change of nominal GDP minus the percentage change of nominal debt. Where the figure is negative that shows that debt was increasing as a share of national income and that government finances were unsustainable. It corresponds rather well with the undulations in Chart 1. Better, I think, than in the commonly seen Chart 2.
What is striking is that British government finances have been on an unsustainable path since 2003 – five years before the financial crash. But it gets worse. Take a look at Chart 4.
The red bars indicate years of recession in the British economy, shrinking GDP. You can see that every period where government fiscal policy has become unsustainable has been preceded by a period of recession. Except one, the expansion under the last Labour government which began in 2003.
One of the hot political potatoes in Britain in the last few years has been the question of whether or not the last Labour government overspent. I think the above shows, quite unequivocally, that they did.