Private saving, public borrowing

By Chris Dillow, 19 February 2010

In the last couple of days, we've had not just one but five pieces of news about the public finances. The obvious news was yesterday's announcement that the government borrowed £4.3bn in January. But there have been four other items relevant to the public finances. The Council of Mortgage Lenders says mortgage borrowing fell last month, to its lowest level since February 2009. The Bank of England says companies repaid debt in Q4. A survey by Hermes Euler found that firms' free cash flow has continued to rise. And today's figures showed a steep drop in retail sales. What have these to do with government borrowing? Plenty.

Of course, this is a mere accounting identity, in the sense that everything has to balance out. It doesn't tell us the direction of causality. It's theoretically possible that the private sector is saving in anticipation of the higher taxes necessitated by government profligacy.

This, however, is unlikely to be the whole story. There's a much more plausible story. The banking crisis has forced the private sector to save, partly by denying credit to people who want to borrow and partly by inducing a recession which has made companies and individuals unwilling to borrow.

As the private sector - corporate and individual - has saved more and borrowed less, so the public sector has borrowed more. The mechanism through which this has happened is, of course, that increased private saving has caused a recession, which in turn has reduced tax revenues and increased pressure upon the government to loosen fiscal policy to cushion the economy.

In this context, the news that the private sector is still saving rather than borrowing has worrying implications. I don't just mean that it tells us that government will borrow a lot. It also tells us that it would be dangerous for the government to try to drastically cut its borrowing soon. As long as the private sector is in the mood to save, efforts to cut public borrowing will merely depress demand. It is only when firms and households regain the appetite and capacity to borrow that government can reduce its borrowing safely.

For this reason, I agree with those economists who have written to the FT. Efforts to cut borrowing now, as a rival group urged, "would not produce an offsetting increase in private sector aggregate demand. and could easily reduce it."

Yes, this will not always be the case. There'll come a time when the government will have to reduce its borrowing. But this time is not now.

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