The UK's ever increasing burden.

UK Debt Costs Surge

The FT recently ran an article https://www.ft.com/content/b25903fd-2ebe-4f65-aa20-c21d873946f3 highlighting the surge in interest costs for the UK Government.

The article correctly focuses on the relatively high proportion of UK debt that is index-linked and hence has been subject to large increases because of the high levels of inflation.?The article goes on to focus on the long-term risks to UK debt sustainability.?“Concern among ratings agencies on the UK’s credit outlook comes after the Office for Budget Responsibility, the UK’s fiscal watchdog, warned that public finances were in a “very risky” position, with government debt on course to hit 310 per cent of gross domestic product in 50 years.”

The issue of sovereign debt sustainability is likely to fill more column inches in the years ahead and not just in relation to the UK.?If the government’s finances are already looking shaky, surely somewhere between here and 310 per cent of GDP the debt burden will become infeasibly high, even if the arithmetic tells us that is where we are headed.?This in turn brings into question the issue of fiscal dominance, an issue addressed in a recent paper by Charles W. Calomaris of the St Louis Federal Reserve.

https://files.stlouisfed.org/files/htdocs/publications/review/2023/06/02/fiscal-dominance-and-the-return-of-zero-interest-bank-reserve-requirements.pdf

Fiscal dominance is the possibility that accumulating government debt and deficits can produce increases in inflation that “dominate” central bank intentions to keep inflation low.?The size of the debt and deficits mean that the government must issue non-interest-bearing debt (printing cash) to fund itself.?The use of non-interest-bearing debt as a means of funding is also known as “inflation taxation.”?The alternative is that the government must fund itself at market rates which will likely be too high for it to bear without nominal default.

In a world of huge and growing debts and deficits there is a hard ceiling on the level of real interest rates that governments can afford to pay.