Eli5: Where does the government get its debt from and why is it bad for government debt to increase?

Question

Who does the government borrow money off to get credit to increase spending? And why is it seen as so bad for the government to increase its debt? I guess the main thing that I want to know is who holds a government accountable for their debt and what will happen if a government just continues to borrow and increase their debt?

In: Economics

Answer 1

Government debt isn’t always bad. It can be. But sometimes you need it.

You’ve heard of a budget deficit? This is where all of the governemnt income (income, corporate tax, trade tariffs, sales tax) is less than its exependitures. But, 1) a government doesn’t get its income in a steady stream, its in bursts – tax deadlines etc. 2) you make your budget based on what you think you need to spend, but emergencies happen. This covid-19 thing for example. Suddenly you’re spending way more than your budget had allowed.

So you borrow – this comes in the form of government bonds. Frankly, if the government can’t be trusted to pay back its debts we’re in big trouble. They don’t offer lots of interest, but its pretty safe. So risk-averse investors will go for the few % points they get.

Who buys em? You can. Your bank can. Your mutual fund can. Companies can. Other countries can. Why this vs. other investments? its safe and the growth is known. Lets say you’re a company and you know 5 years from now you need to build a brand new factory. In the bank your money is only making 3%. If you buy 5 year government bonds, you’ll make 7%, and its about as safe.

And if a country continues to borrow, but never pay back their debts? That’s a default – remember what happened to Greece? Greece owed lots of debt to other European countries. Instead of cutting government spending or raising taxes to pay back their debts, they simply took on more debt. Eventually they couldn’t even pay the interest on their existing debts.

So the other countries like Germany said “Ok, thats it! No more loans. Cut your spending, raise taxes don’t waste your money. Pay us x amount and THEN we’ll see about MAYBE lending you more money.”