True Burdens of Deficit Spending

1
True Burdens of Deficit Spending

• And National Debt

2
What is the budget deficit?

• Budget deficit amount that expenditures exceed
  receipts in a period of time (usually a year)
• Tax revenues government spending Budget
  surplus (negative is deficit)

3
What is the national debt?

• National debt total value of accumulated debt
  used to pay yearly deficits

4
How do we pay for our deficits?

• Government bonds bought by the public.
• Safe investments because guaranteed by the U.S.
  government.
• For sale to any member of the public.
• Maturity dates from 30 days to 30 years.
• Buy bond for 90 now and receive 100 a year from
  now.

5
Our Current Debt

• Current national debt in nominal terms is 7.4
  trillion, as of October 15, 2004.
• 3.1 trillion is held by the government 4.3
  trillion is held by the public.
• (Bureau of the Public Debt at http//www.publicdeb
  t.treas.gov/opd/opdpdodt.htm)

6
Debt as a Percentage of GDP

• Total nominal GDP is 11.0 trillion in 2003 (real
  GDP is 10.4 trillion).
• Our total debt is about 67 of nominal GDP.
• Our public debt is about 39 of nominal GDP.
• (GDP stats from the Bureau of Economic Analysis
  at http//www.bea.doc.gov)

7
National Debt Per Capita

• U.S. population estimated to be 294,548,431 on
  October 18, 2004.
• 25,224 per person in 2004 (nominal dollars).
• (Population statistics from the U.S. Census
  Bureau at http//www.census.gov/cgi-bin/popclock)

8
Interest on the Debt

• Nominal interest payments were 321.6 billion
  last year (15, or almost one-sixth, of public
  spending in the last year)
• (Interest payment statistics from Bureau of
  Public Debt and government spending
  figures2174.3 annualized for second quarter of
  2004from Bureau of Economic Analysis )

9
Cyclical Deficits

• In times of recession, it is natural to have a
  deficit tax revenues decrease and we do not
  want to reduce government spending because that
  would put us deeper into recession.
• In times of boom, it is natural to have a
  surplus tax revenues increase and we do not
  want to spend it or give it back in tax cuts
  because that will heat up the economy even more
  (boom the boom)

10
Structural Deficits

• How can we simplify out these affects of
  government policy from the budget figures? The
  structural deficit tells us how much we would be
  spending and taking in under current system if we
  were at full employment and needed no fiscal
  policy changes.
• Tax revenues ( taxes lost due to recession)
  government spending (- spending due to social
  programs) structural deficit
• Structural deficit is deficit caused by anything
  other than natural economic causes

11
Argument 1 Against the Debt

• Complaint
• Our children and grandchildren will be burdened
  by heavy interest payments and will have to pay
  it off with high taxes.

• Response
• Most of the debt is owned by domestic
  citizensthey benefit from owning government
  bonds.
• But it is worrying that 41 of the debt held by
  the public is owed abroad and is a leakage out of
  our economy(source St. Louis Federal Reserve
  Bank at http//research.stlouisfed.org/fred2/serie
  s/FDHBFIN/1)

12
Argument 2 Against the Debt

• Complaint
• Repaying the debt will ruin the nation.

• Response
• Government never needs to pay off the debt,
  because the government does not die. The debt
  rolls over from year to year.

13
Argument 3 Against the Debt

• Complaint
• The government will not be able to pay its debt
  and will go bankrupt.

• Response
• Government can raise money through taxation, an
  advantage a person does not have.
• Government pays debt in its own currency which it
  can print unlimited amounts of (with disastrous
  consequences, of course)an advantage that many
  governments do not have.

14
Argument 4 Against the Debt

• Complaint
• Budget deficits cause inflation.

• Response
• There is more truth here. An increase in AD will
  cause inflation plus if this increase pushes us
  past potential GDP, the economy will self-correct
  by the AS shifting back, causing stagflation.
• This depends on the slope of the AS curve.
• This depends on the policy mix the Fed can use
  contractionary monetary policy to counteract this
  inflation, but more likely it would try to reduce
  the high interest rates caused by a deficit (see
  next slide), further expanding the economy
  (called monetizing the deficit, which will be
  discussed later).

15
Argument 5 Against the Debt

• Complaint
• Budget deficits may crowd out private
  investment.

• Response
• The government competes with private firms for
  your investment dollars, and every bond bought is
  a share of stock or investment not made. (Think
  about opportunity cost.)
• This raises interest rates.
• There is a counter-balance to this effect, called
  crowding in. If you are in a recession, there
  is not much private investment anyway. You need
  to expand fiscal policy to get the economy moving
  again, and that will have a large effect on
  actually stimulating private investment.

16
Overall Conclusions

• Arguments about the debt burdening future
  generations or leading the US into bankruptcy are
  mostly bogus.
• National debt will be a burden if sold to
  foreignersit is a leakage of money and
  investment out of our country.

17
Overall Conclusions II

• National debt will be a burden if contracted in a
  fully-employed, peacetime economy. In this case,
  increased deficit spending will crowd out
  private investment and raise long-term interest
  rates.

18
Overall Conclusions III

• Deficit spending is necessary in cases where
  expansionary fiscal policy is needed.
• A balanced budget amendment would tie the hands
  of policy makers and leave only the Fed to help
  boost the economy out of recession. It might
  also require the exact wrong policy response to a
  recession when tax revenues have dropped, it may
  require decreased spending to balance the budget.
  We want to encourage balanced budgets in normal
  times, but we do not want to legislate it.

19
Overall Conclusions IV

• Most debt has been accumulated in reasonable
  cases war or recessions. The deficits of the
  late 80s and 90s, though, were created in a
  healthy, peacetime economywhich is why they were
  so worrisome.

20
Overall Conclusions V

• Part of our miracle economy in the mid-90s was
  a deliberate policy mix of contractionary fiscal
  policy (cutting spending, raising taxesthereby
  balancing the budget and moving towards surplus)
  and expansionary monetary policy to counteract
  the depressionary effects of these policies.
  Since both contractionary fiscal and expansionary
  monetary policy reduce interest rates, our
  economy responded amazingly well with
  unprecedented increases in private investment.