The Economic Effects of Public Sector Borrowing

Abstract

If tax revenues are less than net public expenditure (i.e. gross expenditure minus income from charges) a deficit will occur. This deficit has to be financed by the public sector borrowing requirement (PSBR). Short-term borrowing will always be necessary in order to smooth out differences in the timing of expenditures and tax receipts during the course of the financial year. It is usually financed by the sale of 90-day treasury bills. The concern with the PSBR relates to long-term borrowing of several years or more, usually financed by the sale of gilt-edged securities (‘gilts’). Gilts are fixed-interest British government securities traded on the stock exchange. They are a very secure financial asset since it is certain that interest will be paid, and that they will be redeemed (bought back) by the government on the due date. Hence they are almost as good as holding gold, almost ‘gilt-edged’. However they are not totally risk-free since their market value can fall during the issue period. Sale prior to the redemption date could therefore lead to a capital loss (or gain) being incurred. Inflation also reduces their real interest rate and their real redemption value.