Transcript Deficits and Debt - John Zietlow

Deficits and Debt
Chapter 12
McGraw-Hill/Irwin
Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.
Deficits and Debt
• The core critique of fiscal stimulus focuses on
the budget consequences of government pumppriming
– How do deficits arise?
– What harm, if any, do deficits cause?
– Who will pay off the accumulated national debt?
12-2
Budget Effects of Fiscal Policy
• Keynesian theory highlights the potential of
fiscal policy to solve macro problems
– Fiscal policy: The use of government taxes and
spending to alter macroeconomic outcomes
• Use of the budget to stabilize the economy
implies that federal expenditures and receipts
won’t always be equal
12-3
Budget Surpluses and Deficits
• Deficit spending: The use of borrowed funds
to finance government expenditures that
exceed tax revenues
• Budget deficit: Amount by which government
spending exceeds government revenue in a
given time period
Budget
government
tax

–
0
deficit
spending
revenues
12-4
Budget Surpluses and Deficits
• If the government spends less than its tax
revenues, a budget surplus is created
• Budget surplus: An excess of government
revenues over government expenditures in a
given time period
12-5
Budget Deficits and Surpluses
Budget Total
(in billions of dollars)
Revenues
Outlays
Surplus (deficit)
2004
2005
2006
2007
2008
2009
2010
1,880
2,154
2,407
2,568
2,524
2,159
2,289
-2,293
-2,472
-2,655
-2,729
-2,983
-4,004
-3,669
(413)
(318)
(248)
(161)
(459)
(1,845) (1,380)
Source: Congressional Budget Office
12-6
A String of Deficits
Budget deficits are overwhelmingly
the rule, not the exception.
12-7
Keynesian View
• Budget deficits and surpluses are a routine
feature of counter-cyclical fiscal policy
• The goal of macro policy is not to balance the
budget but to balance the economy at fullemployment
12-8
Discretionary vs. Automatic Spending
• At the beginning of each year, the President
and Congress put together a budget blueprint
for the next fiscal year
• Fiscal year (FY): The 12-month period used
for accounting purposes; begins October 1 for
the federal government
12-9
Discretionary vs. Automatic Spending
• Current revenues and expenditures are largely
the result of prior year’s decisions
– Only about 20 percent is discretionary spending
– Uncontrollables account for roughly 80 percent
• Discretionary fiscal spending: Those
elements of the federal budget not determined
by past legislative or executive commitments
12-10
Discretionary vs. Automatic Spending
• Since most of the budget is uncontrollable,
fiscal restraint or stimulus is less effective
• Fiscal restraint: Tax hikes or spending cuts
intended to reduce (shift) aggregate demand
• Fiscal stimulus: Tax cuts or spending hikes
intended to increase (shift) aggregate demand
12-11
Automatic Stabilizers
• Most uncontrollable line items in the federal
budget change with economic conditions
• Automatic stabilizer: Federal expenditure or
revenue item that automatically responds
counter-cyclically to changes in national
income, like unemployment benefits, income
taxes
12-12
Cyclical Deficits
• Cyclical deficit: That portion of the budget
balance attributable to short-run changes in
economic conditions
– The cyclical deficit widens when GDP growth
slows or inflation decreases
– The cyclical deficit shrinks when GDP growth
accelerates or inflation increases
12-13
Structural Deficits
• To isolate effects of fiscal policy, the actual
budget balance is broken down into cyclical
and structural components
Total budget cyclical
structural


balance
balance
balance
12-14
Structural Deficits
• Structural deficit: Federal revenues at full
employment minus expenditures at full
employment under prevailing fiscal policy
• Part of the deficit arises from cyclical changes
in the economy; the rest is the result of
discretionary fiscal policy
12-15
Cyclical vs. Structural Budget Balances
(in billions of dollars)
Fiscal Year
Budget Balance
= Cyclical Component
+ Structural Component
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
+ 236
+ 128
- 158
- 378
- 413
- 318
- 248
- 161
- 459
- 1667
+ 94
+ 19
- 62
- 84
- 46
- 21
-8
- 28
- 76
- 310
+ 142
+ 109
- 96
- 294
- 367
- 297
- 240
- 133
- 383
- 1357
Source: Congressional Budget Office (June 2009)
Changes in the structural component result from policy changes; changes in
the cyclical component result from changes in the economy.
12-16
Structural Deficits
• Only changes in the structural deficit measure
the thrust of fiscal policy
– Fiscal stimulus is measured by an increase in the
structural deficit (or shrinkage in the structural
surplus)
– Fiscal restraint is gauged by a decrease in the
structural deficit (or increase in the structural
surplus)
12-17
Economic Effects of Deficits
• Crowding out: A reduction in private-sector
borrowing (and spending) caused by increased
government borrowing
• Crowding out reminds us that there is an
opportunity cost to government spending
• Government borrowing to finance deficits puts
upward pressure on interest rates
12-18
Public-sector output
Crowding Out
g2
g1
b
Increase in
government spending . . .
a
c
Crowds out private spending
h2
h1
Private-sector output
12-19
Economic Effects of Surpluses
• Four potential uses for a budget surplus:
–
–
–
–
Spend it on goods and services
Cut taxes
Increase income transfers
Pay off old debt (“save it”)
• The economic effects are the mirror image of
those for deficits
12-20
Crowding In
• Crowding in: An increase in private-sector
borrowing (and spending) caused by decreased
government borrowing
• When the government reduces borrowing, it
takes pressure off market interest rates
• As interest rates drop, consumers will be more
willing and able to purchase big-ticket items
12-21
Cyclical Sensitivity
• Crowding in depends on the state of the
economy
• In a recession, a decline in interest rates is not
likely to stimulate much spending if consumer
and investor confidence is low
12-22
The Accumulation of Debt
• The U.S. government has had many more
years of budget deficits than budget surpluses
• National debt: The accumulated debt of the
federal government
12-23
Debt Creation
• When the Treasury borrows funds it issues
treasury bonds
• Treasury bonds: Promissory notes (IOUs)
issued by the U.S. Treasury
• The national debt is a stock of IOUs created by
annual deficit flows
12-24
Historical View of the Debt/GDP Ratio
12-25
Who Owns the Debt?
• The national debt creates as much wealth for
bondholders as liabilities for the government
• Liability: An obligation to make future
payment; debt
• Asset: Anything having exchange value in the
marketplace; wealth
12-26
Ownership of Debt
Source: U.S. Treasury Department (2008 data)
12-27
Ownership of Debt
• 72 percent of the national debt is internal
• Internal debt: U.S. government debt
(Treasury bonds) held by U.S. households and
institutions
• External debt: U.S. government debt
(Treasury bonds) held by foreign households
and institutions
12-28
Burden of the Debt
• The debt has historically been refinanced
– Refinancing: The issuance of new debt in
payment of debt issued earlier
• Most debt servicing is simply a redistribution
of income from taxpayers to bondholders
– Debt service: The interest required to be paid each
year on outstanding debt
12-29
Burden of the Debt
• Opportunity costs are incurred only when real
resources (factors of production) are used
• The true burden of the debt is the opportunity
costs of the activities financed by the debt
12-30
The Real Trade-Offs
• Deficit financing tends to change the mix of
output toward more public-sector goods
• The burden of the debt is the opportunity cost
of deficit-financed government activity
• The primary burden is incurred when the debtfinanced activity takes place
12-31
Economic Growth
• Future generations will bear some of the debt
burden if debt-financed government spending
crowds out private investment
• The whole debate about the burden of debt is
really an argument over the optimal mix of
output
12-32
Repayment
• Future interest payments entail a redistribution
of income among taxpayers and bondholders
living in the future
12-33
External Debt
• External financing allows us to get more
public-sector goods without cutting back on
private-sector production (or vice versa)
• As long as outsiders are willing to hold U.S.
bonds, external financing imposes no real cost
12-34
Public-sector Output
External Financing
g2
b
d
a
g1
h2
Extra output
(imports)
financed with
external debt
h1
Private-sector Output
12-35
Repayment
• Foreigners may not be willing to hold bonds
forever
• External debt must be paid with exports of real
goods and services
12-36
Deficit and Debt Limits
• The only way to stop the growth of the
national debt is to eliminate the budget deficit
that created it
• Deficit ceiling: An explicit, legislated
limitation on the size of the budget deficit
• Debt ceiling: An explicit, legislated limit on
the amount of outstanding national debt
12-37
Dipping into Social Security
• Social Security Trust Fund has been a major
source of federal funding for over 20 years
• Surpluses have largely resulted from Baby
Boomers paying more in payroll taxes than are
paid out in benefits to the retired
• The Trust Fund balance shifts from surplus to
deficit soon after 2014
12-38
Deficits and Debt
End of Chapter 12
McGraw-Hill/Irwin
Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.