Deficit and debt: Does anyone know the difference?

“OK, so there’s the water in the tub…”

In a recent conversation, a Labour Party member told me that the coalition was “borrowing more than we did in power”. I pointed out that this was wrong, that the deficit, what we are “borrowing”, is, in fact, down by a third under this government. He replied: “The deficit may be but the current government is still borrowing more money than the last government.”

You could write this off as simply the pig-headed economic illiteracy of a paid-up member of the party that helped us into the current mess. After all, Ed Balls, Labour’s man on the economy, can stand up in front of Parliament and say “The national deficit is not rising…er…is rising, not falling” (he was right the first time). But then you hear Nick Clegg say that the coalition is working to “wipe the slate clean for our children and our grandchildren”. Even David Cameron himself announced that “We’re paying down Britain’s debts”.

You begin to wonder if anyone knows what they are talking about. I’ve addressed the issue of what exactly is happening to the British government’s finances before but it seems it needs repeating.

We have two concepts here: a stock and a flow. Think of it like a bathtub. The stock is the water in the bathtub, the flow is the water either flowing in or out of the tub through the taps or plughole.

In this analogy the debt is the stock, the water in the tub; the deficit is the flow, the water pouring in from the tap (if our government was running a budget surplus water would be flowing out through the plughole but we’re some way off worrying about that). In other words, the deficit (flow) is the amount by which the debt (stock) is increasing.

Thus, it is possible to have a situation like we have now where the debt is increasing while the deficit is decreasing (imagine yourself turning off the tap and seeing the flow of water dwindle – water is still flowing into the tub). Borrowing is down, what has been borrowed is up.

In the final year of the last Labour government Alistair Darling borrowed £156 billion. In 2012 George Osborne borrowed £99 billion. The deficit had fallen but while ever there is any deficit at all debt will be rising. Another way of putting it is to say that in his last year Darling increased the debt by £156 billion and last year Osborne increased it by £99 billion.

This is why you can have a chart like this…

showing falling deficits coexisting with a chart like this…

showing rising debt.

This might all sound a rather long-winded way of stating the obvious but a ComRes poll late last year found that 49 percent of people wrongly think “The Coalition Government is planning to REDUCE the national debt by around £600 billion between 2010 and the end of this Parliament in 2015”. The correct answer, that “The Coalition Government is planning to INCREASE the national debt by around £600 billion between 2010 and the end of this Parliament in 2015”, was given by just 6 percent.

The British government’s out of control spending is the central issue in British politics today yet there is mass ignorance as to what is really going on with it. In large part this can be attributed to the misleading statements pumped out by the sloppy Cameron and Clegg and the dishonest Balls.

What actually is happening to the British government’s finances under Cameron and Clegg is that the debt is growing and will continue to grow but the pace at which it grows, the deficit, is declining. This is simple stuff even if our politicians struggle with it.

This article originally appeared at The Commentator

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12 thoughts on “Deficit and debt: Does anyone know the difference?

  1. Pingback: An encounter with a bigot | Manchester Liberal

  2. “The British government’s out of control spending is the central issue in British politics today…”

    No it’s not. The British government’s LACK of spending is the central issue in British politics today. The UK issues its own floating currency, so can and should spend up to the inflation barrier (= full employment). Monetary sovereigns retain control over interest rates, so there is no risk of suffering penal rates due to an increase in the debt. Japan is instructive in this regard.

        • It might be about to implode after one more stab at Keynesian stimulus after 20 years of failed Keynesian stimulus. Either way, right now Japan certainly does not show that “Monetary sovereigns retain control over interest rates” no matter what.

          • “failed stimulus”? Dig deeper and you’ll find that the periods of (weak) stimulus map to (weak) growth in GDP, while periods of consolidation map to falls in GDP/recession. That there’s been a tiny spike in yields says nothing about the government’s monopoly control over rates. Bonds will ALWAYS be desired as they are risk-free, interest bearing assets. And in the highly implausible event there are no takers, BOJ steps in and, voila, government can spend!

            • In other words, as soon as the stimulus is withdrawn the economy tanks again. If it doesn’t stimulate it’s not much of a stimulus. Since 1992 Japanese government debt has risen from about 50% of GDP to about 230%. On Keynesian theory Japan should have boomed. In fact it’s flatlined.

              You say this spike has been tiny, given Japan’s sovereign debt is 230% of GDP you can’t honestly say that. And besides, according to your thinking it shouldn’t be happening at all. Let’s look again at what you said, “Monetary sovereigns retain control over interest rates”. As we see that’s wrong, they don’t always. Sometimes they lose control. Japan might be proving that now. And you brought it up.

              • There’s some truth in what you say – had the stimulus been big enough, things could have been different. Sadly, even states that are monetarily sovereign can’t resist austerity hawks entirely. But despite this, the reality is that Japan didn’t too bad: low inflation, respectable levels of employment, and low rates… a set of economic markers that persistently, but amusingly, baffles those without a grasp of monetary sovereignty.

                And no, I wasn’t wrong about Japan retaining control over bond rates. Yield does not equate to (coupon) rate. Yes, yields can fluctuate in line with market demand, but the rate is ALWAYS at the discretion of the government. And since bonds cannot, by definition, fund the spending of a currency issuer, markets are in no position to start demanding higher rates.

                • “had the stimulus been big enough” So you don’t think increasing the deficit from 50% of GDP to 230% of GDP was “big enough”? This is the problem with Keynesianism, it never fails it’s just not tried enough. Or, as Sraffa wrote in his copy of The General Theory, “Head I win, tails you lose”

                  Your second paragraph is a rather hopeless confusion I’m afraid. The government, assuming it is also the money issuer (you seem to be ignoring central bank independence or that it might have other goals such as price stability), can guarantee that it will never pay more than a desired coupon but only if it promises to buy the bonds from itself if no one will buy those bonds at the cpoupon rate (and that is what the Japanese bond spike suggests is the case). In short, the governing arm issues bonds and the monetary arm prints the money to pay for them. One arm of government prints bonds and the other prints the cash to pay for them.

                  But what then? The money handed to the government by the monetary authority in exchange for bonds is spent by the government and generates inflation. In other words, as I’ve put it elsewhere, the argument is that we don’t need to worry about turning into Greece because we always have the option of turning ourselves into Zimbabwe.

                  PS I have just one rule on this blog; no quoting of old, unfunny adverts.

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