By ADRIAN LOWCOCK 03/07/2009
UK Government debt is likely to reach £175 billion by the end of this year or 12% of Gross Domestic Product (GDP), a proportion of which not seen outside of wartime. The astronomical level of debt is due, in part, to the huge sums of money required to bail out the banking system.
The normal rules of prudent public finance are to allow for the peaks and troughs in the economic cycle to compensate for each other, i.e. in the good times governments save money and in the bad times, such as recession, they are able to budget for the loss of taxes received and increase public expenditure to stimulate the economy. Unfortunately, this time around the system was abused and excessive spending in the boom years meant we entered this recession with a large public deficit.
The situation was made significantly worse by the speed and severity of the recession.
Inflation
Western governments have spent the last twenty years tackling inflation, seen as the bane of modern economies, but some might now be willing to ease up on this policy. Rising inflation is good for those with a large amount of debt, reducing the cost of servicing the debt, as well as bringing down public spending (in real terms) because it is easier to issue pay rises that do not keep up with the rate of inflation, than it is to cut salaries or make redundancies.
Controlling inflation may be out of the Government’s control, as many of the determining factors are out their hands. Salaries are one of the biggest contributing factors and they are unlikely to increase significantly in a period of rising unemployment. Indeed, with some companies asking their employees to work for free the pressure seems to be downwards. Commodities also contribute significantly to inflation. Increases on prices will be difficult to pass on to a consumer when there is still a massive over-capacity in the global economy and weak demand. Any significant rises in this sector could send economies back into recession very quickly as higher prices dampen demand.
With the Government stuck between a rock and a hard place, tough action will be required. Read Monday’s article covering our thoughts on what it will do and how you can best prepare to minimise the potential impact.
If you would like to discuss anything you have read in this article please call our Advisers on 020 7189 9999.