Gavin McCrone: A rush to repay is neither necessary nor desirable

Clearly it is a serious matter: as everyone knows, debts have to be kept under control if they are not to result in greater problems for the future.

But so much has been said about this, usually in general but alarmist terms that it would not be surprising if the public were confused. How did it arise? Is it the government's fault? How serious a problem is it and what should be done about it?

It is necessary first to distinguish between the government's annual budget deficit and the accumulated national debt, a distinction that is often blurred when politicians talk about it.

The budget deficit (or surplus) gives the balance of the government's revenue and expenditure in any one year; the national debt is the accumulation of past indebtedness.

If the budget is in continuous heavy deficit that will of course result in a rising national debt. Both are normally measured as a percentage of the country's output or GDP.

In the eurozone countries are supposed to keep their annual deficits to not more than 3 per cent of GDP so that with GDP growing at between 2 and 3 per cent a year, this will enable national debt as a percentage of GDP to be held more or less constant.

In the UK the budget in the years immediately preceding the crisis was in deficit. Not enormously so, averaging between 2.7 and 3.6 per cent of GDP, but considering that these were boom years, it should really have been in surplus.

As the recession took hold, it reached 5.3 per cent in 2008 and a forecast 12.6 in 2009, one of the highest in Europe but only slightly above that in the United States.

National debt on the other hand was among the lowest of large OECD countries – 46.9 per cent of GDP in 2007 compared with 62 per cent in the United States, 65 per cent in Germany, 70 per cent in France, 113 per cent in Italy and 167 per cent in Japan.

The UK debt was also low by historical standards. It was over 100 per cent of GDP in the middle of the 19th century and fell gradually to 33 per cent at the beginning of the 20th century. It then rose dramatically in the First World War and was over 150 per cent through most of the inter-war years.

It rose again in the Second World War to a peak of over 200 per cent in 1948, before coming down gradually to its lowest post-war level of 39 per cent in 1992 before rising to 52 per cent in 1997, the year the Labour Government took office.

Budgets not only in Britain but throughout Europe are in heavy deficit during this recession. As jobs are lost and businesses close or cut back, tax revenue falls and expenditure on benefits rises.

Economists call this the automatic stabiliser, because attempts to prevent it would require draconian cuts in public expenditure and increases in taxation that would depress the economy further.

This circularity in public finance is not always sufficiently recognised by those who advocate taking urgent steps to reduce debt.

In addition, most governments have deliberately tried to boost their economies with fiscal stimulus; this has been important but, compared with the automatic stabilisers, has had only a modest effect in raising the deficit.

The deficit in the UK, the US, Ireland and Spain is much larger than in Germany, France or Italy because these four countries had a huge bubble of private debt, mainly associated with the housing market.

Individuals and businesses are now frantically trying to put their finances back in order and consumption expenditure has fallen dramatically, depressing the economy.

This has the effect of substituting a public deficit for private debt. In addition, governments in several countries, but especially the UK and the US have had to bail out the banks with taxpayers' money.

Had they not done so, people would have lost their savings, apart from the amount covered by the inter-bank guarantee.

In Scotland, the currency notes of our banks would have become worthless.

In time much of this will be self-correcting as bank shares will be sold back into the private sector as the economy recovers.

But in the meantime successive years of high deficit will raise the national debt substantially, peaking, according to the latest forecasts at over 90 per cent of GDP in 2011.

Similar levels are forecast for Germany, France and the US. In Japan and Italy it will be substantially higher.

Obviously, steps will need to be taken to cut the budget deficit, stop the debt rising and, hopefully, to reduce it.

Opinions differ, among economists as well as politicians, on how soon this should be done.

I have taken the view that to try to start this process before the economic recovery is properly under way would only prolong the recession; this is also the view taken by the IMF and the National Institute for Social and Economic Research.

But much depends on confidence in the markets. Worries are expressed that the credit rating agencies might downgrade UK debt from its present triple-A status, leading to a rise in the interest rates. But because this depends so much on psychology, I deplore the alarmist talk of some opposition politicians.

There is a real danger that they could talk us into a crisis. The truth is that if UK debt is downgraded, the same should apply to the debt of the US and several other countries.

How far is this crisis the fault of our government? We should have had a budget surplus in the boom years. But Ireland and Spain both had budget surpluses before the crisis and have been just as badly affected as us. Steps should certainly have been taken to tighten regulation on the banks and to check the huge increase in private borrowing that fuelled the boom.

But such steps, particularly those affecting mortgages, would have been deeply unpopular.

And if the government were to blame for this, no opposition politician, with the honourable exception of Vince Cable, was trying to hold them to account.

Gavin McCrone was formerly chief economist at the Scottish Office.