Although government borrowing does increase the money supply, the monetarist view of a direct link between money supply and inflation is wrong, as proved when Britain experienced recession under Margaret Thatcher. In order to control the money supply the government cut borrowing and spending, which in theory would reduce the money supply, inflation and unemployment but interest rates had to rise to stop consumer borrowing, which in turn increased the exchange rate. High interest rates curbed consumer borrowing, which reduces demand for products, along with a high exchange rate ruining demand for exports and high interest rates meaning entrepreneurs costs increase, thus reducing profit significantly. The increase costs will lead to inflation and entrepreneurs will cut back on labour and therefore trying to control the money supply and not borrowing can be inflationary. Trying to reduce or control the money supply does keep inflation low but unemployment increases and a recession can occur and therefore government spending is not the enemy of employment. Although government spending can cause inflation and eventually unemployment it is possible to control government spending without inflationary consequences. If the government borrows to invest and repays the debt when in a boom (from increased tax revenues) then government spending is viable and not inflationary.
If the government is not borrowing to invest then this is also inflationary. Borrowing to provide jobs or stimulate demand will cause demand-pull inflation, where excess demand raises the price level. If the government continues borrowing and spending on stimulating demand then unemployment will stay low, due to entrepreneurs seeing the increase in aggregate demand resulting in demanding more labour but inflation will increase (as shown in the Phillips curve).
Inflation causes uncertainty for entrepreneurs and therefore will cut costs and this usually means having a smaller workforce, therefore borrowing not to invest is inflationary and the enemy of employment. Stagflation is the long-term effect of demand management, increasing inflation and unemployment and ruins an economy.
Government borrowing can discourage private sector borrowing for investment, which reduces aggregate demand and can cause unemployment. When the government borrows interests rates are high to encourage banks to lend. This in turn reduces private sector borrowing for investment. The higher rate of interest leads to a higher exchange rate because the demand for sterling will increase due to speculators cashing in on the high interest rate. A higher exchange rate is bad for exports, as British goods will seem more expense on the world market, demand for labour in the export industry will also decrease and therefore government borrowing can lead to unemployment. Although a high exchange rate is good for imports and therefore firms will be paying less for their raw materials and may be able to reduce their prices in order to boost demand, if this did take place then unemployment would not increase. Keynesian economists do not believe crowding out occurs, their views are that the more the government spends more than it receives there will be a net injection in the circular flow of income. This will lead to rises in national income and eventually savings will increase and create extra money for investment and a rise in consumption also. Thus demand for labour will stay the same or increase and therefore public sector borrowing is not the enemy of unemployment.
If the government borrows too much then there will have to be increases in taxes, mainly corporation tax and this will also contribute to some unemployment, but the public sector does help employment in some ways. Education and training (funded by the government) provides a skilled, desirable workforce, which will encourage British firms to employ British workers instead of looking for other skilled workers in an increasingly globalized world. The National Health Service also reduces the amount of residual unemployed and therefore contributes to keeping employment levels high. Government borrowing should only occur if for investment purposes and if it will be repaid over the cycle, otherwise it destroys entrepreneur confidence and eventually leads to unemployment.
Andrew Catherall.
