Government aid for coronavirus – what does this mean?

Borrowing can be good or bad. For a leaky roof, you might get away with buying a bucket as a short-term fix, but in the long term you could have a problem when there’s a deluge
Cahir Gilheaney

OVER the past couple of months, faced with a life-threatening pandemic, governments have put in place a range of economic and fiscal measures, the scale and scope of which have not been seen in this lifetime. The cost of these is currently running to multiples of billions of pounds in the UK alone, and we're not out of the woods yet.

This week we're turning our attention to the question of where this financial aid is coming from. And the answer is government debt.

Unfortunately, the question of debt is not an easy one to answer and it involves a risk assessment. Borrowing can be good or bad, depending on how the money is used.

Consider, for example, borrowing to repair a leaky roof. While you might get away with simply buying a bucket to catch the leak as a short-term fix, in the long term, you could have a much bigger problem on your hands when there's a deluge. The investment you make in repairing or even replacing your roof now could save you big money in the long run.

It is a somewhat similar, albeit much less trivial, situation for many economies around the world and the cost is in human capital: jobs, household incomes and financial stability for the whole economy.

Businesses becoming insolvent means redundancies and unemployment and the knock-on effect on a whole chain of suppliers, their staff and customers. Post crisis, recovery can be sluggish and new job creation can take time. People who are out of work or lose their job often find it hard to re-enter the workforce.

Cumulatively, this can cause a lacklustre recovery and is what is known as the “hysteresis effect” – causing a deeper scar on the economy.

The goal of many of the current fiscal measures funded by government borrowing (including the coronavirus job retention, or furlough scheme) is to protect jobs and businesses and keep people in work. This, surely, should be seen as money well spent in the long run.

But this doesn't mean that governments can borrow infinite amounts of money. There are natural limits to how much a government can borrow. The two big ones are interest rates and inflation.

Governments borrow through issuing debt in the form of bonds to investors; the higher the risk of a country being unable to meet its obligations, the higher the rate of interest demanded by the investor (Italy is a good example of this).

Interest rates are currently at all-time lows as market volatility has seen large flows of investors' money towards government debt, preferring the perceived safe haven of bonds during the recent economic turmoil.

This makes it easier for governments to borrow more without being forced to pay much higher interest rates. At the same time, inflation remains flat.

Technically, a government that can issue in its own currency will never go bankrupt, as it can ‘print' money to purchase its own debt. However, too much of this will eventually lead to hyperinflation, also leaving the country worse off.

So governments around the world are currently in an enviable position to borrow for the longer term. And although we are by no means out the other side of this current crisis, government borrowing to finance widespread fiscal support is likely to be money well spent as they are doing it for reasons which, at least on the surface, make sense, and will hopefully reduce the long term or permanent scarring of the economy.

:: Cahir Gilheaney is Barclays Wealth manager

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