The UK government can deploy the spending necessary to reach its net-zero goals, despite current debt-to-GDP levels being relatively high, a new paper argues.
The report, published by the Centre for the Understanding of Sustainable Prosperity, warns against cutting back spending. It says such a move would be driven by outdated thinking about the likely impact of higher debts, and an overly-rigid conception of how monetary and fiscal policy should operate.
The authors say there is little evidence that current public debt levels are likely to negatively affect economic growth. But they acknowledge that insofar as the government wants to prevent its debt ratio from increasing further, the current larger debt ratios can constrain government action.
This is because any increase in interest rates reduces the deficit the government is able to run without the debt ratio going up. And if interest rates increase above the growth rate, then the government will have to run a surplus if it wants to prevent its debt ratio from rising further.
However, the report contends that greater flexibility in the use of monetary and fiscal policy, and better coordination between them, could address this problem. It says monetary policy could take on a greater role in ensuring debt sustainability and fiscal policy could focus more on managing demand.
For example, the paper imagines a situation in which the public debt ratio is high, and an increase in interest rates would require a cut in spending to avoid the debt ratio rising further. In this instance, instead of raising interest rates, it may be preferable for the government to lean on fiscal policy to reduce demand, and avoid a double contraction due to higher interest rates and cuts to government spending.
The paper also suggests that unconventional monetary policies such as credit guidance could be used to curb or stimulate bank lending to specific sectors or for specific activities.
“Such an approach would allow the central bank to affect economic activity without altering interest rates – something that may be useful when public debts are high,” say the authors.
The argument that the UK’s net-zero goals can be achieved while keeping its debt levels manageable was echoed in a report by the Office for Budget Responsibility last year. It found that under a scenario where the government moved quickly to take the necessary action, the addition to public sector net debt would be smaller than that resulting from the pandemic. The report also said that not taking action would result in far greater costs in the future.
This page was last updated February 25, 2022
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