Adam Smith Institute

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A debt ceiling could be just what we need

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debtThe current carnage in financial markets owes much to excessive debt levels, which have been so irresponsibly run up in recent years: the chickens are coming home to roost with a vengeance. In the EU, the paramount issue is the Euro, a project driven by politics and light on basic economic principles – one of which is that ‘you cannot buck the market’.

The Euro crisis is now probably reaching its denouement. The outcome is very unpredictable, although a split between a hard Euro and a soft Euro seems very possible. In the US, the President has struggled to prevent federal expenditure breaching the massive $14.3 trillion permissible public debt ceiling. To do so, heavy public expenditure cuts will be implemented.

The existence of such a ceiling may seem a crude financial mechanism but it has undoubtedly concentrated minds. But should a public debt ceiling – perhaps as a percentage of the previous year’s GDP – be imposed in the UK?

There is, in fact, a Private Members Bill, which aims to introduce such a ceiling: its chances of enactment are, though, slim. The evidence in recent decades is of a seemingly inexhaustible growth in public expenditure, especially over the last decade. Hence, public sector net debt is currently close to a barely imaginable £1 trillion – prior to various off-balance sheet liabilities, including public sector pensions.

Whilst the Coalition Government is slowing the growth in public expenditure, it continues to rise, especially once the net interest line is included. A mechanism to impose a debt limit can only be beneficial, providing the markets believe it is genuine and enforceable. The fact that the current yield on UK 10-year gilts is below 3% is testimony more to the dire situation elsewhere than to the Government’s belt-tightening policy here. Of course, this scenario could change – but a public debt ceiling could offer some valid defence against ever-rising public expenditure.