Does it matter that our public debt to GDP ratio is projected to rise to 90 percent? Other countries have even higher ratios, for example, Italy and Japan. After the war, the UK had a ratio in excess of 250 percent, but somehow managed to avoid economic ruin. These cross country and historical comparisons suggest that given time, our current debt problem will sort itself out. So what is wrong with high levels of public debt?
Let's deal with the cross-country issue first. Before the crisis started, the UK had a comparatively low level of public-sector debt, which meant that the government interest rate bill was also comparatively low.
Now, with borrowing exploding, the government will have to find more money to service its debts. This means less money for everything else. For example, if the government today decides to borrow more to spend on schools, it will have less in the future. Schoolchildren today will take resources away from future generations of schoolchildren.
This debt servicing squeeze on public expenditure is something at all heavily indebted countries understand. High levels of public sector debt redistributes income across generations and from taxpayers to bond holders and recipients of public sector extravagance.
The experience of Italy and Japan teaches another lesson. Both countries expanded government borrowing to maintain economic growth. It was a strategy that failed. Japan's sorry experience with Keynesian policies is particularly instructive. Back in the mid-80s, Japan had a very low debt to GDP ratio. It had a banking crisis, the economy crashed, and despite repeated attempts to kick start the economy with government spending, growth remained disappointing, leaving Japan with frightening levels of public indebtedness.
What about our own historical experience? After the war, the UK government had a major problem with debt. By 1970, it had largely resolved the problem. The methods, however, were not pleasant. In order to ensure low interest rates, the financial system was heavily regulated. Banks operated a cartel, keeping rates low. Household credit was difficult to obtain, and mortgages rationed. Exchange controls prevented people from investing their money abroad.
With inflation running higher than the interest rate, the real value of post-war debt was gradually eroded. This strategy of financial repression ensured that bondholders and savers ended up paying for the war.
The UK's post-war debt reduction strategy would not appeal to people today. However, the government and the Bank of England are putting together a very similar approach. One of the explicit objectives of the Bank of England's quantitative easing strategy is to reduce the yield on long term government paper. The monetary policy committee's bank rate is almost zero. The Bank of England and the government are working hard to increase inflation. The results so far have been encouraging. Despite the slowdown in economic growth, inflation remains very much alive.
After the war, most savers, watching their investments evaporate, shrugged their shoulders philosophically and weighed their loss against the greater good. Savers today are unlikely to take such a publicly minded approach. Why should people, who prudently saved and avoided debt, be forced to pay for reckless property speculators? You can be sure that if the government runs a debt to GDP ratio of 90 percent, it will only be reduced by expropriating savers through inflation and negative interest rates.