How the Treasury pays for the bail-out

By Hugh Pym
Economics editor, BBC News

The government is having to borrow a lot of money

How will the government pay for its bank support package?

How will the public finances look after yesterday's announcement, coming on top of the state support for Northern Rock and Bradford and Bingley?

An initial estimate by the Institute for Fiscal Studies (IFS) suggests government debt could reach the highest level since the 1970s.

If governments want to spend more money than they've budgeted for, they generally have to borrow it.

They go to the money markets and sell more government bonds, in effect IOUs.

Golden rule

The Treasury will need up to £50bn to inject into the banking system.

That will add to the stock of public sector debt.

One of Gordon Brown's rules as chancellor was keeping debt to no more than 40% of the UK's annual economic output or gross domestic product (GDP).

But that was quietly abandoned as the full cost of the nationalisation of Northern Rock was calculated, and the figure went above 43%.

The IFS calculates that government support for the Bradford & Bingley rescue deal will add a sum equivalent to another 3% of GDP.

If you add on the £50bn of new banking support, around 3.5% of GDP, you get a public sector debt figure close to 50% of the British economy's annual production.

We have not seen anything like that since 1976 when Denis Healey was chancellor and the then Labour government was battling an economic crisis.

Temporary measures?

The Treasury will argue that the various deals to prop up banks could well be unwound within a couple of years.

In other words, these are temporary factors which do not properly reflect the underlying state of the public finances.

If you remove these from the debt equation you get back below 40% of GDP.

But there is a recession looming and that is likely to push debt higher as tax revenues fall away and unemployment benefits payments rise.

So it is highly likely that public sector debt will push up above 40%.

Hence the rewriting of the fiscal rules now going on at the Treasury.

Then there is the small matter of the £200bn of Bank of England lending to banks in exchange for mortgages - and the £250bn worth of bank debt which the government will guarantee.

These won't be added to public sector debt as there won't necessarily be any losses - but they are still big liabilities hanging over taxpayers until the credit crisis eases.