Government debt

Government debt (also known as public interest, public debt, national debt and sovereign debt)[1][2] is the debt owed by a government. By contrast, the annual "government deficit" refers to the difference between government receipts and spending in a single year.

Government debt can be categorized as internal debt (owed to lenders within the country) and external debt (owed to foreign lenders). Another common division of government debt is by duration until repayment is due. Short term debt is generally considered to be for one year or less, long term is for more than ten years. Medium term debt falls between these two boundaries. A broader definition of government debt may consider all government liabilities, including future pension payments and payments for goods and services which the government has contracted but not yet paid.

Governments create debt by issuing securities, government bonds and bills. Less creditworthy countries sometimes borrow directly from a supranational organization (e.g. the World Bank) or international financial institutions.

In a monetarily sovereign country (such as the United States of America, the United Kingdom and most other countries, in contrast with eurozone countries), government debt held in the home currency are merely savings accounts held at her central bank. In this way this "debt" has a very different meaning than that of the debt acquired by households who are restricted by their income. Monetarily sovereign governments issue their own currencies and do not need this income to finance spending. In these self-financing nations, government debt is effectively an account of all the money that has been spent but not yet taxed back. Their ability to issue currency means they can always service the interest repayments on these savings accounts. This is why bonds and gilt-edged securities are considered the safest form of investment.

A central government with its own currency can pay for its spending by creating money ex novo.[3] In this instance, a government issues securities not to raise funds, but instead to remove excess bank reserves (caused by government spending that is higher than tax receipts) and '...create a shortage of reserves in the market so that the system as a whole must come to the [central] Bank for liquidity.' [4]

History

The sealing of the Bank of England Charter (1694)

During the Early Modern era, European monarchs would often default on their loans or arbitrarily refuse to pay them back. This generally made financiers wary of lending to the king and the finances of countries that were often at war remained extremely volatile.

The creation of the first central bank in England—an institution designed to lend to the government—was initially an expedient by William III of England for the financing of his war against France. He engaged a syndicate of city traders and merchants to offer for sale an issue of government debt. This syndicate soon evolved into the Bank of England, eventually financing the wars of the Duke of Marlborough and later Imperial conquests.

Centre: George III, drawn as a paunchy man with pockets bulging with gold coins, receives a wheel-barrow filled with the money-bags from William Pitt, whose pockets also overflow with coin. To the left, a quadriplegic veteran begs on the street. To the right, George, Prince of Wales, is depicted dressed in rags.
A new way to pay the National Debt, James Gillray, 1786. King George III, with William Pitt handing him another moneybag.

The establishment of the bank was devised by Charles Montagu, 1st Earl of Halifax, in 1694, to the plan which had been proposed by William Paterson three years before, but had not been acted upon.[5] He proposed a loan of £1.2m to the government; in return the subscribers would be incorporated as The Governor and Company of the Bank of England with long-term banking privileges including the issue of notes. The Royal Charter was granted on 27 July through the passage of the Tonnage Act 1694.[6]

The founding of the Bank of England revolutionised public finance and put an end to defaults such as the Great Stop of the Exchequer of 1672, when Charles II had suspended payments on his bills. From then on, the British Government would never fail to repay its creditors.[7] In the following centuries, other countries in Europe and later around the world adopted similar financial institutions to manage their government debt.

1815, at the end of the Napoleonic Wars, British government debt reached a peak of more than 200% of GDP.[8]

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