Page last updated at 17:20 GMT, Sunday, 7 December 2008

Pub-talk economics questions answered

By Kevin Peachey
Personal finance reporter, BBC News

Dinner party
The downturn has become regular dinner party conversation

A year ago, not so many conversations in the pub or around the dinner table would have been dominated by the state of the economy.

But now it is difficult to get through an evening out without somebody raising the subject of the credit crunch, recession in the UK, or the global economic downturn.

At times the subject can be difficult to follow. On other occasions, people might not get the chance to ask about some basic principles of the economy.

These questions are like the awkward relations in the economic family - everyone is aware of them, but a little too embarrassed to ask about them.

So BBC News has asked two experts to answer some key queries about the downturn. They are Melanie Powell and Derek Fry, from the Derbyshire Business School at the University of Derby.

Q: The national debt is to shoot up following the measures announced in the pre-Budget report. Who are we in debt to?

A: The national debt is 649bn, or 42.9% of the annual output of the economy. It will top a massive 1 trillion by 2013 according to the pre-Budget report fiscal projections.

This is mainly borrowed from overseas governments, some UK institutions and some individuals.

Q: Where does the government get the money to pay for measures such as the bank bail-out?

A: The government borrows the money by selling gilt-edge stocks to anyone who wants them anywhere in the world.

Gilt-edged stocks are when you lend money to the government which then pays you regular interest payments, and pays you back the nominal value of the gilt at a specified future date.

Q: Why is deflation a problem, surely it would make everything cheaper? And what is stagflation?

A: A bit of inflation is all right if it is low and expected.

Stagflation is the problem of high inflation with slow or negative growth.

Persistent deflation is a problem because everyone puts off spending until later and this slows the economy and deepens recession.

Melanie Powell and Derek Fry
Melanie Powell and Derek Fry are from the Derbyshire Business School

Q: Why is the price of my home so important to the state of the wider economy?

A: The value of your house is probably your biggest valued asset, so when house prices rise above inflation, you feel richer, receive more in a sale, or you are able to borrow more against the value of your home to spend.

The extra spending increases sales for businesses, supports more jobs and fuels economic growth. Of course, when house prices fall, the opposite happens, spending falls, jobs are lost and the economy slows.

Q: I keep on hearing that my mortgage rate is determined by the inter-bank lending rate, Libor. If so, what is the point of the Bank of England's interest rate?

A: In the past, the Libor rate followed the Bank of England's rate, so changes in the Bank Rate reduced mortgage rates.

Banks no longer trust each other because of bad debts, so the risk of lending to each other is greater and the Libor rate stays higher.

Reducing the Bank Rate can still affect non-Libor rate lending and investment. For example a lower Bank Rate can reduce foreign investment in the UK.

Q: If a business goes bust owing me money, usually I'll only get some of it back as a creditor. If a bank goes bust, and I owe it money through a loan or mortgage, do I have to pay all of it back?

A: If a bank goes bust, the administrators will sell off assets like mortgages to pay back some of the debt, so you will have to pay back your mortgage to whoever buys the mortgage assets.

If you have savings with a bank, you have lent the bank money. Unlike most creditors who do not get their money back when a business goes bust, the government has guaranteed virtually all savings in UK banks.

Q: Is there such a thing as a risk-free investment?

A: The closest you can get to a risk-free investment is buying government investments because governments rarely go bust.

If they do, like Iceland, the International Monetary Fund will bail them out. The problem is the lower the risk, the lower the return.

Q: Rather than cutting VAT to encourage us to spend, why does the government not just give us each a lump sum? Does the government have the power to lend to individuals itself?

A: The government would have to pay to administer any new lump sum payout. As it is, business bears the cost of VAT changes.

VAT is such a widely applied tax that it is probably the simplest and most politically acceptable method of giving money back to individuals.

Q: Can anyone in the UK be prosecuted for making a mess of the global economy?

A: No. There is no global legal structure for this. Enjoy the blame culture and you can always use your vote at the next election.

Q: Is it possible to get to a stage when banks and building societies simply lend out what they get in as deposits?

A: If bank shareholders want high profits then banks make these profits by expanding loans.

They can't do this with deposits alone. Even with tighter controls on bank lending, the government would need to nationalise the banks to achieve this.

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