Ann Pettifor

1945, government debt, bond markets, sterling – and all that.

27 October, 2009

I promised to explain – to Alastair, a reader of this blog –  the link made earlier between 1945 and today’s supposed government ‘debt crises’.  Sorry if its a little long – but a promise is a promise.

I consider the scaremongering around government debt to be nothing more than an over-egged and salted buttermilk pudding dished up by the economic quackery of the Her Majesty’s Opposition.  Not unlike that ancient remedy for (verbal) diarrhoea, it is intended to induce intellectual constipation – in those that absorb it in spoonfuls at the Institute of Fiscal Studies, the Treasury and City of London.

We should have nothing to do with such childish prescriptions.

To illuminate and evidence my point let me offer you (below) a chart – with data provided by Her Majesty’s Treasury (Public finances databank, Table A10  and with thanks to my colleagues in the Green New Deal group.

This is a chart of Britain’s public debt as a share of GDP – from 1858 until 2002. For American readers I will paste a chart of US public debt for a similar period on my Huff Post blog in a day or two. The same economic lessons apply, even though much of the history is different.

Britain’s debt today – as a proportion of the national cake or GDP – is about 55% and rising. It is expected to hit 70% soon. Study the chart and you will see that it was twice that in 1858 – about 100% of GDP.

After the outbreak of war in 1914 it started rising. The 1929 crisis caused it to rocket upwards, as indeed did the financing of a very destructive war – World War II.  In 1945 Britain’s debt stood at 250% of GDP – roughly 5 times what it is today.  At that point an extraordinary thing happened (largely as a result of Keynes’ sound advice.)

The heavily indebted Labour government began to spend – as soon as legislation was agreed by Parliament.

Labour started to invest in a bold and visionary project: – a publicly funded health service free at the point of use –  the NHS – in 1946. (The American Congress is today proposing a similarly bold investment in a ‘public option’ for their health service.)  Back then, the Labour government carried out a massive slum clearance programme, and built houses. They revived the ancient universities, provided pensions and welfare to the poor. They trained ex-soldiers to become teachers.

What happened, you might ask, to the total public debt, as a result of this flouting of the economic orthodoxy – and  flagrant extravagance?   Well – exactly what Keynes had predicted would happen.  The debt fell.   Steadily, but unremittingly – as a share of GDP.    Look closely at the chart.

This is because government spending kick-started economic activity. (Of course it had done so during the war too – but on destructive, not productive activity. That had helped defeat a profound threat – Nazism – but had not helped much to fix losses and generate income.)

So thanks to government intervention, economic activity revived the comatose and exhausted body that was the post-war UK economy. Soon it began to recover. With recovery, government revenues rose, expenditure on  unemployment benefits fell – and hey presto! – government repaid its debts, which fell dramatically as a share of GDP.  Soon the spending began to pay for itself.

So there you have it. Government spending encourages economic activity, brings down unemployment and hauls in tax revenues from economically active citizens, consumers and private entrepreneurs. These taxes then lower the government’s debt – and before you can say Nye Bevan – the spending has paid for itself!

And please if another Tory or Lib Dem MP repeats the childish and tiresome mantra: “just as we balance our household budget, so should we balance the government’s budget” – just smack them on the wrists, and send them back to school.

When I – a householder  – spend into the economy – on say, insulating my property – nobody rewards me by paying tax revenues into my bank account – to help reduce my overdraft and balance the books.   On the contrary, builders, the local hardware store, insulation experts, energy advisers –  drain my bank account and offer only their goods and services in exchange.

When the government spends or invests in the economy – and creates jobs –  it is rewarded with tax revenues – not just from individual taxpayers, but from businesses where the newly employed spend their earnings. Businesses that in turn use that newly-found income to spend on new investments which create more jobs and more and more taxes for government……over, and over again! ( In economics this is known as ‘the multiplier’. It involves arithmetic – don’t go there unless you are good at sums.)

That is why,  and how, government investment is different from household investment.

And that is why government investment pays for itself.

And to top it all, if government stops paying out unemployment benefit – equivalent to say, a household stopping its contributions to an unemployed student – it saves money – in this case, just like a household.

“Look after the unemployment, and the budget will look after itself.” (Keynes, January 1933, CW XXI, p. 150)

Oh,  and two more rebuttals for those Tory and Lib Dem MPs: sterling falls when government debt rises for one reason alone: a lack of confidence in the British economy.  (US government debt is rising dramatically, but the dollar rose yesterday. Why? Because investors still have confidence in the US economy.)

Anyone buying sterling can see – because they read the  newspapers – that Britain’s economy is not recovering. It is still weakening.  Once Britain’s economy recovers, confidence in sterling will recover. But the economy will not recover, unless government investment is allowed to substitute for a collapse in private investment.  Once it does – sterling will rise again.  As night follows day.

Third and final rebuttal: ‘the bond markets will not buy government debt – government debt will ‘crowd out’ private sector debt – and will force up interest rates. The government will be held to ransom by the bond markets.’

It is tiresome to have to rebut such arguments, but rebut we must.

The bond markets are not the King of England. They are servants to a sovereign state, begging to make a quick, safe, but effortless capital gain.  (And since the financial crisis, many of these investors (like my old mother) would not dream of putting their money anywhere else except into safe UK government bonds.)  Keynes’ advice to the British government way back then was to ignore the bond markets. Instead – back in 1940 – he persuaded the Treasury to oblige (perhaps the word is force) the banks – some of which are today already in public ownership or part-public ownership – to lend to the Treasury at very low rates of interest.  The bankers were not given a choice.   Their loans were given a fancy name: “Treasury Deposit Receipts” or TDRs – and they helped to finance the war, as well as post-war economic recovery.  (I am grateful to Prof Vicky Chick and Dr. Geoff Tily for these historical references.)

As the economy recovered on the back of affordable interest rates, so the banks thrived.

And a final piece of advice to the Labour government should it consider following Keynes’s remedies: if the banks prove difficult – remove all taxpayer-backed guarantees and subsidies – and embark on a heavy programme of regulation.

After all, forget not: you are the government – and they owe you.


24 thoughts on “1945, government debt, bond markets, sterling – and all that.”

  1. The UK budget is like a household budget in that us in the UK needs to provide as good as we get.
    Since money only goes in

    peoples pockets cutting public spending is a euphamism for putting people out of work.
    Joined up thinking would entail connecting what needs to

    be done to those people who are absorbing manpower in relatively useless or even obstructive activities.
    In a family houshold money is often

    spent without debate by anybody over the profit or loss of each activity. The family considers the benefit to the family.
    One of the most

    inefficient organisations is the houses of parliament. They provide a bottleneck for improvements because every issue whatever its nature has to be

    debated by 650 people at once. The result is gridlock.
    How in a democracy do we crack that one?

  2. Dear Ann

    Many thanks indeed for that link to that report and the above graph! Excellent

    information about debt as the mother of interest. Did you notice that 4% of the Government’s budget are “debt interest” and 6% “military”?

    For what matters is that this interest is not backed by anything except a fancy IOU from the Government to someone in the City and the Government

    pays “real money”.

    So what is the “money” that workers get for their labour and salesmen for their products?

    Why pay interest when

    the Government has not only the power but even gets income (seigniorage) from printing money and minting coins?

    Who is in control of the

    money supply and who controls the controllers?

    This petition on money creation says it in nice and simple ways on

    More power to your passionate elbows!
    Organiser, Forum for Stable Currencies

  3. Thanks for this useful compact argument in favour of public spending which I will circulate to my fellow


    One point I would like to add: the stimulus would be that much more powerful if we started taxing the unearned increment from

    rent. Public infrastructure investment leads directly into land values. By capturing all land rent for public benefit via an annual land value tax,

    with regular reassessments, that public investment would be self-funding. It would also kill the boom/bust cycle for good.

  4. Dear Ann,

    Thank you for your great and informative blog.

    However the argument for public spending will always be rejected

    by the powers that be.

    For the capitalist interests unemployment is a good think along with the lack of social support. It makes the work

    force meeker and more concerned with survival than with politics or information.

    Like you said before, we’re all turkeys voting for

    Christmas so much much worse must happen to us before we open our eyes.

    As it is now, people are very happy to vote for the ending of the

    welfare state for the poor. Because the welfare state for the rich is alive and kicking and never was better.

  5. Thank you again, Ann, for such a clear and comprehensive account. Since I’ve been reading you, I feel I have

    begun to understand economics. Please keep writing. I just hope people are listening to you and reading you.

  6. If government spending pays for itself just as Keynes said it would, why has it not done so in

    Japan? There are many other similar examples. Even Paul Krugman now says that the deficit spending should only be expected to pay 40% of itself. I

    do not think that the Keynesian case has much evidence to support it as I argued in my book on Keynes.

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  8. Thanks for the comments, folks, glad you like it.

    Hunter Lewis – you seem to have fallen into the trap of most

    anti-Keynesians, defining and demonising Keynes as someone who pursued a single policy: economic recovery through fiscal stimulus. Unfortunately

    because my blog majors on the issue of government expenditure, that is the impression I give too. But Keynes was clear: monetary policy should be

    used intelligently and effectively to prevent the need to ever have to resort to fiscal policy.

    For government to substitute for the

    collapse of private sector investment – as we recommend – is a sign of massive failure on the part of the monetary authorities. Government here is

    the helicopter with the long rope, rescuing an economy that has fallen off a cliff.

    The role of the monetary authorities is to prevent that

    happening….and please don’t argue that interest rates were low before the crisis: Greenspan et al lowered rates – in reaction to the bursting of

    the dotcom bubble – and then steadily raised rates through 2004, until high rates broke the proverbial sub-primers backs…..and they collapsed

    beneath the costly burden of their debts….

    To understand Japan it is necessary to understand the failure of the authorities there to

    manage monetary policy in ways that would have prevented a debt-deflationary spiral, a liquidity trap and Keynes’s famous string that would not

    move when pushed. Read Graham Turner on Japan – he was there and I strongly recommend his review of policy management there:


    suffered a catastrophic implosion of property prices during the early 1990s. The Bank of Japan was slow in cutting interest rates. Eventually, they

    were slashed to 0.5% in 1995, but it was too late. Multiple banking failures in 1997 and 1998 drove the economy further into recession.

    “After 11 years of falling house prices, Japan adopted Keynesian-style monetary reflation. The Bank of Japan expanded its balance sheet fourfold,

    buying government debt to drive long-term interest rates below 1%. The recovery has been fitful. After 18 years, property prices are still falling.

    But if the policy had been implemented much earlier in the downturn, Japan could have averted much of the turmoil that engulfed the country.”

    And then remember what Keynes wrote:

    ” I repeat that the greatest evil of the moment
    and the greatest danger to economic progress in

    the near future are to be found in the
    unwillingness of the Central Banks of the world to allow the market-rate of interest to
    fall fast

    enough” (1930, p. 207).

  9. The graphs are erroneous because they are not comparing like with like:

    1. The Victorian numbers

    show UK government borrowing used to fund the entire British Empire compared to UK GDP. The rapid growth of UK GDP from the empire explains why

    the ratio reduced in the period up to the First World War.

    2. The figures after the first and second world ward are distorted by having an

    abnormally lo denominator (GDP).

    3. The postwar figures include the debts incurred in funding a substantial part of british industry.

    4. The current figures exclude substantial liabilities (National Rail, nuclear decommissioning, PFI, civil service pensions, etc) which together

    add at least another 80% of GDP to government liabilities, and the extent of these liabilities is much higher than in earlier periods.

  10. Pingback: 1945, government debt, bond markets, sterling - and all that. | called2account

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  12. “The heavily indebted Labour government began to spend”

    It did?

    Actually, the post war Labour

    Government was fiscally contractionary:

    “The immediate aftermath of the Second World War saw the

    steady closure over 1946 and 1947 of the huge wartime deficit, producing a few years of surplus as government expenditure was reined in by


  13. Pingback: Web links for 29th October 2009 | ToUChstone blog: A public policy blog from the TUC

  14. I entirely agree with Ann that Keynes put monetary policy first. To think otherwise is a common error. My

    book on Keynes emphasizes this. I do think that central bank interest rates were too low in the 2000’s, not only in relation to inflation ( in the

    US under inflation for three years) but importantly in relation to yield spreads.

  15. Keynes’s point was that if you increased aggregate demand, aggregate income and employment would rise, as a result tax revenues would

    be up and benefit expenditure would be down.
    From the start of the great depression right through to the 1970s, aggregate demand was raised by

    both lower long-term rates of interest and higher government expenditure. The former led to higher rates of private fixed capital investment.

    Government expenditure rose from figures of around 11% in the 1920s, after a gradual increase through the mid to late 1930 and then great increases

    during the war, the rate stabilised at around 22% for much of the post-war era. Basically, the activity of government doubled. (The figures in this

    paragraph exclude transfer payments such as pensions.)
    Those who judge the ‘fiscal stance’ on the basis of the public finances simply betray

    their misunderstanding of Keynes’s theory. The outcomes of this period wholly vindicate his reasoning. Government expenditure was increased

    greatly, national income rose and the public finances improved. The public finances are not a measure of the extent of stimulus, they are a measure

    of outcome.
    Vital to the success of Keynes’s fiscal policies were his monetary policies. IN the 1930s, the spending was preceded and supported

    by a general reduction in rates of interest across the spectrum. This involved a great extension in the use of short-term bills, and hence

    additional savings on interest (because short bills carry lower interest than long). Later on, borrowing was financed by the creation of new money.

    As Graham Turner has argued, this sequencing of monetary and fiscal policy was not a feature of the actions of the Japanese authorities.

    Moreover a good deal of the expansion of the public sector balance sheet followed from the socialisation of private sector debts. In the 1930s,

    Keynes considered that the way to restore asset values was to restore income.
    Krugman is also mentioned. It is not clear to me how Krugman

    derived his 40% figure, certainly it is not supported by the only recorded experience of a comparable recession.
    But Krugman is a ‘Keynesian’

    at best, and ignores the great part of Keynes’s analysis which was concerned with the operation of monetary economies. Hunter Lewis rightly argues

    that Keynes’s monetary policies have been neglected, but so too have the monetary dimensions of his fiscal policies.

  16. Alex, you commented that the graph does not compare like with like. I take your point
    that the numbers must be subject

    to all sorts of uncertainties, but as far as I am aware it is the best historical account – which is why the Treasury makes it available.

    It would be very interesting to see series adjusted for the factors mentioned, could you provide one with appropriate sources? I would still

    suspect that the post WWII point would be the highest ever, and that it was at that point that the Labour government began to build the NHS etc.


  17. Oops…overlooked Tim Worstall’s point about the public sector deficit…and the reference to the IFS paper by Andrew

    Dilnot et al.

    Keynes argued that there was little point in using the deficit as a measure. The preferred measure, the one I have used

    above is total debt as a share of GDP.

    The reason for this is that both low levels of spending, and high levels of spending can result in a

    small public sector deficit. The deficit does not distinguish between high or low levels of spending. I am told that all economists get this


    In fact in the pamphlet Tim quoted, Dilnot and others also question the usefulness of the deficit measure: see here:


    useful is the deficit as a measure of discretionary fiscal policy? One obvious problem concerns the economic cycle – even where there are no

    discretionary changes in policy, an economic downturn will depress government receipts (as falling household and corporate incomes reduce the tax

    base) and at the same time increase expenditures (notably, on unemployment-related social security benefits). Together these effects mean that the

    onset of a downturn will produce a deficit under policies that would previously have achieved balance. Conversely, the onset of a boom can produce

    a surplus on the basis of policies that previously produced balance.”


  18. Ann, could you comment on the potential progress of the Tobin tax, which has raised its beautiful head again recently?

    Sorry to be late in commenting here, but I’ve been prompted by last night’s (Monday 10th November) Radio 4 “Analysis” programme, in which

    Frances Cairncross took the “oh, no, we’ve got a huge public debt, government spending must be slashed and public services will inevitably have to

    suffer” line. My point is really that she simply asserted the need to cut the debt quickly (with only Polly Toynbee speaking against).


    surely you are saying: (a) government debt is, historically, not particularly high, despite Cairncross’s assertions; and (b) even if it were,

    cutting goverment spending is not the answer. I am simply wondering: if we, as a nation, fall for the cut-goverment-spending-at-all-costs line, as

    looks increasingly likely, there is an alternative in tax increases, and a Tobin tax would be a strong candidate for that.

  19. Robin,

    Thanks for this…and yes I feared that was what the Cairncross theme would be. The Tobin Tax however is proposed as a

    global tax….for global public goods. In other words, it maintains the global financial status, but drops ‘sand in the wheels’in the form of a

    tax on international transactions…because it is a global tax (i.e. not destined for any one country) the development community has proposed that

    proceeds be used to fund development/climate changte….Hope this helps. Ann

  20. Thanks to explain

    why 80% of the worldwide populous live on $10 a day but the UK govt. have £13k out on loan for every man, woman child in said kingdom

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  22. Dear Ann

    Although this is quite an old post I can see the wisdom in it.

    I particularly agree with Carol in regards to the power of stimulus being increased
    if we advocate “taxing the unearned increment from rent”.

    Quite a productive think tank you have growing here:)


  23. I know that this post is quite old, but I thought the main reason why the UK could pay off its debt so easily was because the level of inflation as well as GDP growth was much then the level of interest rates. Seeing that now, would you say that Japan could still manage to get out of its recession through a massive increase by banks giving large loans to the government so it can pull demand back up?

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