Ask Amanda: Where does the government get its money from?

2 mins. to read
Ask Amanda: Where does the government get its money from?

When the UK government “borrows” billions of pounds, who does it borrow it from, how does it repay it and at what interest rate?

The UK government has three main sources of revenue:

– Taxes

– Borrowing

– Creation of money (quantitative easing)

When the government spends more than it earns in tax revenue, we see a deficit – this means it may need to look at borrowing money to help fund the deficit.

The government typically borrows from the ‘market’. To do this it issues bonds and gilts which are bought by pension funds and insurance companies which lend the money to the government. This is not creation of money but the transfer of funds into the central bank. The government will have to pay back the money plus interest after the agreed period.

The rate of interest the government will pay will vary depending on the type of debt, it’s maturity and the rate at which the markets were willing to lend. When the bank cut the bank rate to 0.1%, this immediately made it cheaper for the government to borrow money, as it also applies to the effective interest it pays back to lenders (bond purchasers).

Quantitative easing (QE) is a tool the Bank of England has in its armoury to inject money into the economy with the aim of boosting spending and investment by making it cheaper to borrow money.

In June 2020, the Bank of England announced a QE programme to increase its purchases of government bonds to £745bn (from £645bn in March 2020). When the Bank of England buys these bonds, the original bondholder now has the money which they might invest in shares that will provide a higher return. When the demand for financial assets, such as shares, is high this drives demand and consequently the value of the shares goes up. This makes businesses and individuals who hold shares wealthier and the hope is that they will spend that money bringing things full circle to further boost the economy.

We recognise that not everyone classes themselves as a ‘Master Investor’…yet! For those who are new to our site and possibly new to investing too, we want to share our expertise by answering any questions you have. Master Investor’s CCO, Amanda, is learning to invest too, so will be happy to find the answers to your questions or use our network of experts to help answer the question. So, if you have a question about investing or want us to explain something, please send your questions to Amanda by commenting below or by emailing Fire away! 

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