This follows on from Greek finance (1).
The key to understanding is terminology.
Gaining a confident handle on a few fundamental ideas is hugely helpful, I believe. This is probably stuff I should have absorbed when I did O level Economics in – er – 1977 – but for some reason it never really sank in. So the current financial crisis has had some value, however peripheral.
This is money borrowed by national governments.
Governments borrow by issuing securities or bonds.
In principle, governments can guarantee repayment by increasing taxes or printing money.
Not all countries are equally creditworthy, and so interest rates vary.
In some ways we are ill-served by terms such as ‘debt’ and ‘borrowing’, which confuse matters. Margaret Thatcher did not help by likening government finance to managing the household budget. The term ‘sovereign debt’ helps to remind us that government borrowing is different to what happens at a personal level (in my view).
Debt – sovereign debt – is the total amount of money that a government has – cumulatively – borrowed. Apologies for using a household analogy – but it’s equivalent to the total outstanding on a mortgage, for example.
These days the figures are large – we are talking about billions, or hundreds of billions of pounds, dollars, or Euros. Actually billions are no longer sufficient, and we often need to bring in trillions. In the case of Japan – which has a very large debt, and a small unit of currency – we’re starting to look at quadrillions !
Debt is a straightforward idea – but it’s important to distinguish debt from deficit.
Debt and deficit are similar, and both refer to a shortage of money ! However debt is cumulative and relates to the total amount owed, whereas deficit relates to what has changed over a period of time – usually a year when we are talking about government finance.
Again with apologies for using a personal example, but if my credit card bill is £500 in March, and £600 in April, then my debt has increased from £500 to £600, but the deficit was £100 – where deficit gives net difference between expenditure and income.
Debt is the more fundamental concept – but is controlled through deficits. So governments will target deficit reduction – where it is recognised that even a deficit of £1 will increase the debt. The only way to reduce the debt is by turning deficits into surpluses.
Gross Domestic Product – GDP – gives the market value of all goods and services produced by a country in a given period. It provides a good measure of the size of a country’s economy.
Numbers are large, typically in the high billions, or low trillions, for the largest economies.
DEBT TO GDP RATIO
Debt figures are large, and on their own, don’t tell us much. It’s more useful to measure a country’s debt in relative terms, and the most common way of doing this is by comparing debt with the size of that country’s economy.
The debt to GDP ratio is debt expressed as a percentage of GDP.
So if country A has a debt of $1 billion, and a GDP of $10 billion then its ratio is 10%, and if country B has a debt of $110 billion, and a GDP of $100 billion then its ratio is 110%.