Who does the government borrow money from?
UK energy bill plans, coupled with tax cuts, set to increase government borrowing under new PM
These policies will almost certainly force the government to increase the amount of money it borrows.
But where does the UK borrow money from – and what does borrowing mean?
What does borrowing mean?
Each year the government raises funds through taxes which are usually set in an annual parliamentary event, the budget.
He uses this money to finance public services, invest in infrastructure and pay for the welfare state, among other things.
If he spends more money than he earns from taxes and other income, he must “borrow” to cover the deficit, i.e. the difference between the money he has and the money he needs.
If a deficit appears repeatedly on the public balance sheet over a period of time, it becomes known as the national debt.
While you will often hear politicians compare the finances of the nation to the budget of, say, a business or a household, they operate in a different way.
For example, debt can be very long term – up to 55 years – and can sometimes be cheap, meaning a government will borrow more to pay off old debt.
The International Monetary Fund (IMF) describes it as “an important means for governments to finance investments in growth and development”.
Running deficits and going into debt can also be politically useful, as a government could become unpopular if it raises taxes too much.
And, if a recession occurs – an event that can reduce the amount of money provided by taxation – a government is likely to increase borrowing to fund public services.
The problems mainly arise if a country defaults on its debt, that is, it cannot or does not want to repay it.
Who does the UK borrow money from?
The money the UK borrows comes from the private sector, usually from financial institutions like pension funds and banks.
It raises this money from bonds – also known as gilts.
These are essentially promises to pay money to the lender over a period of time, with most of that money being repaid on the final date of the obligation.
Payments before the end of the life of the bond generally consist of interest.
Overall, the private sector views these loans as a low-risk investment vehicle.
Indeed, they guarantee regular repayments to the investor/lender over an often long period.
But they carry a certain risk, because inflation can wipe out the interest if the bond is not indexed.
Similarly, on the government side, issuing bonds (i.e. borrowing) becomes more expensive if inflation is high because investors will want to make a return in exchange for their money.
The index-linked bonds it issues are also likely to become more expensive when inflation is high.
According to Reuters, debt interest for these bonds rose by £19.4 billion in June due to record inflation.
Sometimes the Bank of England (the government body in charge of Britain’s currency) buys them through a process known as quantitative easing – essentially money printing – aimed at stimulating spending and investment and therefore to increase British economic output.
What do Liz Truss’ spending plans mean for borrowing?
We don’t currently know the exact details of how Liz Truss will tackle the cost of living crisis and the looming recession.
But in his speech to Tory members during the election campaign, his speech from Downing Street on September 6 and Prime Minister’s Questions on September 7, we got an indication of his plans.
Ms Truss wants to cut taxes – especially for businesses – to promote economic growth.
Former chancellor Rishi Sunak warned that such a move would worsen inflation.
“The problems with this are twofold,” he told The Times.
“It’s extremely expensive and a lot of money goes to people who don’t need it, and [secondly] if you hold prices constant, supply weighs in, increasing the risk that you will end up with shortages.
As the government will generate less revenue through taxation – with corporate tax and national insurance cuts in sight – it means the country will likely have to rely more on borrowing.
This marks a major shift from previous Conservative administrations, which pursued various policies of “balancing the books” – i.e. reducing the deficit and the national debt – rather than shaking off what they previously called “the magic money tree”.