From Zero to $100 Billion in Sixty Seconds
Published 8 May 2020
By Dr Peter J Phillips, Associate Professor (Finance & Banking) University of Southern Queensland
For years and years, Australian politics was dominated by arguments about economic management and the desirability of a budget surplus. This, despite a plausible case being made for at least a little bit of deficit spending to alleviate a chronic underemployment problem. Just when the Australian government appeared set to report a budget surplus for the first time in more than a decade, the Covid-19 (coronavirus) pandemic changed everything.
First, let’s just be clear about the difference between government debt and the government budget. The budget is the government’s record of revenue and expenses. A government budget deficit occurs when the government’s revenues are less than its expenses. A government budget surplus occurs when the government’s revenues are greater than its expenses. Debt, on the other hand, is the amount that the government owes, usually in the form of government bonds on issue.
While the government steadily tried to work its way back into a budget surplus during the late 2010s, the value of Australian government bonds on issue rose continuously every year following the Global Financial Crisis (GFC). The budget deficit was falling but debt was growing.
In the early 2000s, the government bond market was in danger of drying up because the government had been able to pay down much of its debt. Bonds on issue were around $50 billion. The government was running surpluses of almost $30 billion, giving it plenty of scope to completely pay down the remaining debt. With the GFC, government debt skyrocketed and the value of bonds on issue reached $500 billion in 2017 and continued to grow. Through this time, the government was in no position to reduce this debt given that it was running budget deficits.
Maybe it’s easier to think about all of this in terms of an individual’s budget. A person can earn $100, say, and have expenses of $60 (including interest) and be $50 in debt. Given their ‘budget surplus’ of $40 (i.e. $100 – $60), the person can pay down their $50 debt gradually as long as they keep running budget surpluses. This was the Australian government position pre-GFC. Conversely, the person might earn $100, have expenses of $110 and be in $50 debt. Of course, such a person needs to keep borrowing and their debt increases each year. This has been the government’s position since the GFC. The Australian government dreamed of returning to the pre-GFC state of affairs.
Then the Covid-19 pandemic changed everything, possibly forever. First, the stimulus spending put in place to offset the economic impact of the virus and the ‘lockdown’ was estimated to require new bond issues totalling around $300 billion. This is on top of the more than $500 billion already on issue at the beginning of 2020.
Of course, this is debt, not a budget deficit. If the government was earning lots of money, it might meet its desired expenditures, including the interest on the bonds, and still have a budget surplus. Unfortunately, the increase in required expenditures combined with lower tax revenues due to lower economic activity means that forecasts were changed from a budget surplus of around $6 billion in 2020-2021 to a budget deficit of $100 billion (see the Sydney Morning Herald). This is almost double the post-GFC deficit of $56 billion recorded in 2009-2010. Of course, all of this means that the government will have to keep borrowing to meet any shortfall between its revenue and expenses. Thankfully, interest rates are low!
Discussion Question
What is the interest rate that the government pays on the bonds it issued in 2020? Considering that bonds require a regular ‘coupon payment’ plus the repayment of principal, how long do you think it will be before the government pays down this debt? Will it ever happen?
Further Reading
For those interested in reading more about government debt (including the specifics of bonds), monetary policy and the payments system, go to Chapter 12 of Financial Institutions, Instruments and Markets 9e. Of special interest is the history of budget deficit/surpluses presented in Figure 12.1.