Economist  

Bank warns government borrowing could turn UK into Venezuela

Bank warns government borrowing could turn UK into Venezuela

The UK government should be "paranoid" about taking on significantly more debt, according to Richard Sharp, a member of the Bank of England’s Financial Policy Committee (FPC).

Mr Sharp was speaking at University College London yesterday (30 November) said that while the level of borrowing undertaken by the UK government is fiscal policy, and therefore a matter for politicians, rather than the central bank he feared excessive government debt is a threat to financial stability.

He warned that excessive borrowing could lead to the UK turning into Venezuela.

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He said governments should always leave themselves "fiscal space" that is capacity to borrow for emergency situations, rather than using all of its capacity to issue debt at cheap interest rates in normal times.

The fact that the UK economy is growing, with unemployment at less than 4.5 per cent, indicates the current situation does not constitute an emergency, he said.

Mr Sharp said the government went into the 2008 global financial crisis with room to borrow for that emergency, with the result being the UK was able to borrow at relatively low interest rates and run fiscal deficits to stimulate economic growth.

He warned that significantly increased borrowing when an economy is actually growing can lead to a stark deterioration in a country's creditworthiness and economy.

He said he remembers when Venezuela had a triple A credit rating before it increased borrowing, and it recently defaulted on its debt.

The counter argument to that posted by Mr Sharp comes from Ann Pettifor, an economist and adviser to Labour Party leader Jeremy Corbyn.

She said politicians fretting about the level of debt taken on by governments ignore the multiplier effect.

This is the idea that money borrowed by the government for investment (rather than just spending) multiplies in value as it moves through the economy and so generates more growth and wealth in the economy than it costs to borrow.

An example of the multiplier effect is this: If unemployment is high, then the government decide to build a new road.

They borrow the money to build the road. That creates jobs. The people employed to build the road will be earning more than they received in social security. This extra money is then spent in the economy, in shops, meaning the shops must order more stock and hire more staff, who in turn spend more, so the value “multiplies” through the economy, creating extra economic growth, which should add more wealth to the economy than is lost from interest payments to overseas investors.

The view of Bank of England governor Mark Carney and his colleagues on the Monetary Policy Committee (MPC) is that the current very low level of unemployment means there is little extra growth to be garnered by creating jobs, weakening any multiplier effect.

Mr Sharp said it is economic consensus that the multiplier effect is real, but he said it is most effective as a tool to escape an economic crisis, as it is much less potent when debt levels are already high, as the debt repayments subtract more growth than is generated by the multiplier, creating a negative effect.