University:
London School of Economics and Political Science
Course:
L400 | International Social and Public Policy
Academic year:

2023
Views:

344

Pages:

12
Author:

Prerna T

The Impact of COVID on the public finances Extracts from the OBR's Economic and Fiscal Outlook - Nov 2020 "The coronavirus pandemic has delivered the largest peacetime shock to the global economy on record. It has required the imposition of severe restrictions on economic and social life; driven unprecedented fails in national income; fuelled rises in public deficits and debt surpassed only in wartime; and created considerable uncertainty about the future. The UK economy has been hit relatively hard by the virus and by the public health restrictions required to control it. The virus has also exacted a heavy and mounting toll on the public finances, in our central forecast, receipts this year are set to be £57 billion lower, and spending £281 billion higher, than last year. The Government has committed huge sums to treat the infected, control the spread of the virus, and cushion its financial impact on households and businesses. As support has been expanded and extended, including in the wake of the second wave of infections, Its total cost this year has risen from £181 billion at the time of the Summer Economic Update, to £218 billion at the time of the Winter Economy Plan, to £280 billion in this forecast. In our central forecast, the combined impact of the virus on the economy and the Government's fiscal policy response pushes the deficit this year to £394 billion (19 per cent of GDP), its highest level since 1944-45, and debt to 105 per cent of GDP, its highest level since 1959-60 (Chart below)." Chart 1.1: Public sector net borrowing, central forecast and scenarios Government Bonds How can a government spend more than it takes in through taxes? The answer is that it can issue government bonds. This is the way that governments borrow money from anyone who wishes to lend to them. What are government bonds? Government bonds are mentioned in several parts of the A-level syllabus so they are important for you to understand. Start by watching the first part of the video below. (stop at 2.23) A bond is a way of borrowing money. The most common type of bonds are issued by governments (government bonds) but you can also get bonds issued by firms (corporate bonds). But you can ignore the latter for now as they are not required knowledge for the A-level or IB. A government bond is a way for a government to borrow money from individuals, firms etc. In order to spend on schools, hospitals etc. If government spending was always smaller or equal to tax revenue, then there would be no need for government bonds. Governments issue bonds to borrow money to cover the difference between government spending and tax revenues. i.e. the amount of bonds issued will be equal to the budget deficit, for that reason the budget deficit is sometimes called the Public Sector Net Cash Requirement (PSNCR) and used to be known as the Public Sector Borrowing Requirement (PSBR). Those who buy government bonds are simply loaning money to the government for a fixed period of time. At the end of that period they receive their Initial investment back. And during the lifetime of the loan they usually receive annual interest known as the coupon. The higher the coupon amount, the more investors may want to hold bonds. COVID-19 and UK government debt Source: Office of Budget Responsibilility - November 2020 Chart 1.9: Public sector net debt: central forecast and alternative scenarios 100 Range of November virus scenarios Upside scenorio 120 Downside scenario March fomcast PSR central scenario + SEU 110 November forecast Oulturn Percent of GDP 90 100 80 70 2015-16 2016-17 2017-18 2018-19 2019-20 2020-21 2021-22 2022-23 2023-24 2024-25 2025-26 Soures ONS OBE "the sharp rise in debt to absorb the cost of the pandemic has not undermined the sustainability of the public finances. Indeed, it is more likely that sustainability would have been damaged if the Government had not stepped in to support the private sector." OBR, November 2020. Why do you think this might be the case? There has never been greater reason for the government to spend. With huge parts of the economy shut down, a risk of rocketing unemployment and rising poverty the case for government spending is strong. In economic terms too, now is a good time to spend as the Interest rates at which the government can borrow are extremely low (see chart below for the 10Y government bond yield/interest rate). Government Bond Terminology: Face Value: The nominal amount the government initially sells the bond for and that the bondholder receives at maturity. Maturity: The life of the bond (e.g., 2Y, 5Y, 10Y). Coupon: A nominal amount paid periodically (e.g., £10) throughout the life of the bond. Market Price: The price at which the bond is traded after its initial sale. How Government Bonds Work: The "yield" of a bond is similar to an interest rate on a savings account but not exactly the same. For a savings account, the interest rate is fixed. For a bond, the coupon is a fixed amount, so the yield changes based on the price of the bond.