Exorbitant Privilege Gained and Lost: Fiscal Implications

We study three centuries of UK fiscal history. Before World War I, when the UK dominated global bond markets, the UK’s government debt was not always fully backed by its future surpluses. As predicted by theories of safe asset determination, investors concentrate extra fiscal capacity in a single country, the global safe asset supplier, based on relative macro fundamentals, and its debt growth may temporarily outstrip what is warranted by its own macro fundamentals. After the relative deterioration in UK fundamentals, due to the run-up in debt during World War I and World War II, bond investors focused exclusively on the UK’s own macro fundamentals. Since then the UK debt has been fully backed by surpluses.