Transcript Government Debt - Illinois State University

Government Debt
Stocks & Flows
Flow – measured over a period of time
(annual, monthly)
Stock – measure at a point in time
Income vs. wealth
Investment vs. capital
Gov’t debt vs. deficit
Gov’t deficit and debt
Deficit
G–T
Each year adds to the debt
How big is the deficit and debt?
Debt $400b?
Measure as a percent of GDP
Debt Problems
How can you tell if a corporation is in danger of
defaulting on its debt?
- balance sheet info?
- bond yields
Same for gov’ts.
Debt Crisis
What happens if government debt is too high?
• Must pay high interest rates
– Higher risk
– Increases the deficit/debt
• “Solutions”
– Repudiation
• Gov’t refuses to pay
• Time consistency problem
– Borrow from the Fed (central bank)
• Inflation
• Seingorage – profit to gov’t from inflation
Lending and inflation
• One good – pens
• price of pens today is $0.20
• The bank loans Jane $10 at 10% interest to be paid
next year.
• During the year inflation is 25% - the price of pens
rises $0.25
• Jane makes the loan payment of $11.
What’s the point?
• The $10 today could buy 50 pens
• The $11 a year later buys 44 pens.
• The payment the bank gets is worth less than the
loan.
• To gain value the bank must lend at a rate higher
than inflation.
Real Interest Rates
The real interest rate is adjusted for inflation. We
use expected inflation since future inflation will
affect debts agreements.
ir = i – pe =
nominal rate – expected inflation
The real interest rate is a more accurate measure of
the cost of borrowing.
U.S. Real and Nominal Interest Rates
-6.00
Series1
2011-05-01
2009-12-01
2008-07-01
2007-02-01
2005-09-01
2004-04-01
2002-11-01
2001-06-01
2000-01-01
1998-08-01
1997-03-01
1995-10-01
1994-05-01
1992-12-01
1991-07-01
1990-02-01
1988-09-01
1987-04-01
1985-11-01
1984-06-01
1983-01-01
1981-08-01
1980-03-01
1978-10-01
1977-05-01
1975-12-01
1974-07-01
1973-02-01
1971-09-01
1970-04-01
1968-11-01
1967-06-01
1966-01-01
1964-08-01
1963-03-01
1961-10-01
1960-05-01
1958-12-01
1957-07-01
1956-02-01
1954-09-01
1953-04-01
Real 10 year bond yield
12.00
10.00
8.00
6.00
4.00
2.00
0.00
-2.00
-4.00
How much Gov’t debt is too much?
• Hard to judge
– Japan (2009)
• 200% Debt/GDP ratio
• Real interest rates under 2%
– Argentina repudiated (2002)
• Debt/GDP ratio peaked near 150%
• Expected probability of repudiation
– Many factors involved
– Trust in the gov’t
– Future deficit/debt
• Healthcare
• Social security
Retirement and Medical Care
Table 26-3
Social Security
Projected Spending on Social
Security, Medicare, and Medicaid,
1998-2060 (Percent of GDP)
2004
2010
2030
2050
4.2
4.2
5.9
6.2
Medicare/Medic
•Entitlement
programs
aid
4.1 are
programs
that
the
4.8
8.4 require
11.5
payments of benefits to all who meet the eligibility
Total
8.3
9.0 law. 14.3
17.6
requirements established
by the
Debt Dynamics
D(debt/GDP) = (r – g) (debt/GDP)
+ deficit/GDP
r – real interest rate
g – growth rate of real GDP
If g > r ....
Policy
What is the effect of an increase in G on
debt/GDP?
• Higher deficit (raises debt/GDP)
– higher r
• possible exceptions
– liquidity trap
– hysteresis (De Long)
– Higher productivity – g rises (lowers debt/GDP)
Policy
What is the effect on debt/GDP of an increase in
T?
• Lower deficit (& lower r)
• possible exceptions
– rates already very high
– wrong side of the Laffer curve
– lower productivity – g falls (raises debt/GDP)
Gov’t debt
• 30% - 50% of GDP is OK
• Too high - crisis
– interest rates rise
– inflation and/or repudiation
– how high is too high
• Pay down debt
– low deficits, surplus
– growth
– the higher the debt, the harder it is
• Liquidity trap? Labor supply?
Long Run Growth
Deep History
Real GDP in the U.S.
Long Run
Short run – fluctuations around potential GDP
Medium run
- adjustment to potential GDP
- changes in potential GDP
Long run
- What determines the growth rate trend of
potential GDP?
AS-AD
• SR fluctuations – AD shifts
• MR – adjustment to Yn
• LR – What changes Yn ?
Which of these matters for LR growth?
Table 10-1 The Evolution of Output per Capita in Five Rich Countries Since 1950
Annual Growth Rate
Output per Capita (%)
1950-1973
1974-2000
Real Output per Capita
(1996 dollars)
1950
2000
2000/
1950
France
4.0
1.8
5,519
22,371
4.1
7.4
2.3
2,417
24,671
10.2
2.4
1.8
7,641
22,188
2.9
2.4
2.1
10,601
33,308
3.1
4.1
2.0
6,544
25,634
3.9
Japan
United Kingdom
United States
Average
 The standard of living has increased
significantly since 1950.
 Growth rates of output per capita have
decreased since the mid-1970s.
 Convergence for much (not all) of the world.
Aggregate Production
• Output depends on capital and labor
• Output per worker depends on capital per
worker
• Productivity
Increase in capital – movement along the
production function
Increase in productivity – shift in the production
function
Determinants of Growth
Savings
• build capital through investment
• needed for development
• can the saving rate be too high?
Productivity
• technology and human capital
• determines long run growth rate for GDP
• What improves productivity?
Long Run Policy
• Improve savings/investment
– Financial system
• Savings
– Safety
– Return
• Borrowing (firms)
– Contracts
– Available loans
– Developing countries
• International aid
• FDI
Long run policy
• Improve productivity
– R&D
• Tax breaks
• Patents
– Education/Training
– Property rights
Summary
LR
• productivity matters
• S/I/capital matters
– particularly for developing countries
SR
• Productivity still matters
– & other supply shocks
• Demand shocks
– Autonomous spending
Summary / Policy
• Fiscal policy
– Gov’t spends on public goods
– Increase productivity
• Monetary Policy
– Target inflation
– and output/unemployment?
• LR balanced budget
– stable debt/GDP ratio (30-50%)
– SR implications - difficult
– affect G & T changes on growth
Review Problem
• Show the effect of an increase in autonomous
consumption on expenditure, IS-LM and ASAD. Show the medium run adjustment on the
AS-AD graph.
Review Problem
The Fed acts to raise interest rates. Starting
from natural rates, show the short and medium
run effect of this policy change on graphs of S&D
for Money, IS-LM, AS-AD and the Phillips Curve.
Final Review Questions
2007
Good
Quantity
2008
Price
Quantity
Price
Cars
100
$20
120
$30
Houses
40
$100
44
$100
Given the above information about a country’s
output, find the following using 2007 as the
base year.
a)Growth rate of nominal GDP.
b)Growth rate of real GDP.
Review Problem
Show the effect of an increase in consumer
confidence on an
• Expenditure diagram
• IS-LM graph
• AS-AD
– Start from the natural rate of output.
– Show short and medium run effects.
– What are the effects on equilibrium output and
prices?
Review Problem
Show an inflationary gap on graphs of AS-AD
and IS-LM. Show the result of passive policy on
the graphs.
How could monetary policy help to close the
gap?
How could fiscal policy help? Show the changes
in the graphs in the case of active fiscal policy.
Review Problem
Show an inflationary gap on an AS-AD graph and
the graph of the Phillips Curve.
If the Fed wants to lower/avoid inflation what
does it do?
Show the resulting changes on graphs of money
supply and demand, IS-LM as well as the ASAD and PC graphs.
Review Problem
Starting from the natural rate of output, show
how an increase in the markup affects the
graphs of the wage and price setting equations,
IS-LM, AS-AD and the Phillips Curve. Give two
examples of reasons the markup might increase.
Problem
One analyst says a fall in GDP is due to a fall in
productivity, while another says the cause is a
decrease in investment spending. Show a
separate AS-AD graph for each scenario. What
are the implications for a policy response?