Yes, the government does pay interest on its debt

When was the last time you heard Darling or Brown mention the cost of government borrowing?

Last year, the central government interest bill was ₤32 billion, or roughly 2.2 percent of GDP. Currently, the general government public debt stock, in terms of GDP, stands at 48 percent. Roughly speaking, the government is paying about 4.5 percent on its debt; a figure broadly confirmed by the yield on a 20 year treasury bond.

Looking foward, things are about to get a lot worse. UK public finances are in a complete mess. The government has already committed to the banking system about 90 percent of GDP as loan guarantees and recapitalisations. It also intends to run up a fiscal deficit of 8 percent for the next two to three years. It is not hard to imagine that public debt in terms of GDP could increase to 100 percent of GDP within two or three years.

Assuming that the interest cost in terms of GDP remains the same, the government could end up paying 4.5 percent of GDP in interest payments each year. Even if the government balances its current expenditure and capital investment with its tax revenues, it will still be running a huge deficit.

But what if investors demand a higher yield on government paper. Suppose rates have to go up to 7 percent. Then the government will be an unsustainable deficit. Only dramatic expenditure cuts or huge increases in taxes will bring the situation under control.

There is another more nefarious solution to the government's increasing fiscal difficulties. It could try to destroy the real value of debt by rapid increases in prices. Right now, this is what the Brown, Darling and King are trying to do through quantitative easing. Increased inflation is a now a policy objective. They want to make savers pay for their mistakes through a dishonest and undemocratic inflation tax.