chapter 15: government debt & budget deficit
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Chapter 15: Government Debt & Budget Deficit. Deficit & Debt. Federal deficit occurs when government spending (purchases & transfers) exceeds tax receipts Federal debt is the amount of funds the government must borrow to cover its deficit - PowerPoint PPT PresentationTRANSCRIPT
Chapter 15: Government Debt & Budget Deficit
Chapter 15: Government Debt & Budget Deficit
Deficit & DebtFederal deficit occurs when government spending (purchases & transfers) exceeds tax receipts
Federal debt is the amount of funds the government must borrow to cover its deficit
Money is owed to government agencies, private individuals and firms, and foreign individuals, companies, and countries
Size of Debt
Size of the debt is measured by the debt ratio: government debt as a percentage of the GDP
Debt ratio in U.S. in 1998 = 65, less than Belgium (125), Italy (123), and Japan (93), but more than Australia (40), Finland (59) and U.K. (60)
The Debt-GDP Ratio
The Debt-GDP Ratio (US)
Change in Debt Ratio
Revolutionary War = 45 Civil War = 40WW I = 40 WW II = 120
In recent years, the ratio increased from 22 in 1970 to 40 in 1980 to 60 in 1990 and to 65 in 1998
Deficit & Debt Projections
2000 2010 2020 2030 2040 2050
T 21 20 20 20 20 20G 21 20 22 25 30 43Deficit 0 -1 1 5 10 23Debt 42 21 17 40 93 206
All variables are expressed as percentage of GDP
Deficit & Debt Projections
Receipt shall stay constant at 20%
Spending shall rise from 21% in 2000 to 22% in 2030 to 43% in 2050
Deficit shall rise from –1% in 2010 to 23% in 2050
Debt falling to 17% in 2020 shall rise to 93% in 2040 and 206% in 2050
Measurement Problem 1
Calculating deficit in “nominal” value results in an overstatement of the amount of debt required to cover the deficit
Deficit and debt must be expressed in “real” values; i.e. adjusted for inflation
Measurement Problem 2
Unlike private accounting procedures, government debt does not measure the difference between government assets and liabilities
Capital budgeting, that accounts for assets and liabilities, measures changes in capital
Measurement Problem 3
Government debt does not account for Social Security liabilities
Unlike public debt, the government can refuse making Social Security payments if funds are insufficient
Measurement Problem 4
Deficit and debt move pro-cyclically: they fall during a slump and rise during a boom
To solve this problem, the government calculates a “cyclically-adjusted” budget deficit, which the amount of deficit at full employment
Traditional View of Debt
A tax cut increases disposable personal income, consumption spending, employment, and income. A higher AD results in higher income and real interest rate as the IS curve shifts to the right.
In the long-run, price level will rise, lowering SRAS to reduce income to its full employment level
Ricardian View of Debt: AnalysisForward-looking consumers may not spend their additional disposable income to cause growth
With a tax cut, people shall expect a future spending cut as the government would not want to run a deficit
Likewise, consumers view debt accumulation as a sign of higher future taxes, thus saving money for that purpose
Ricardian View of Debt: Case Study
In early 1992, President Bush reduced the federal income tax withholding requirement to increase disposable income and stimulate growth
Forward-looking consumers expecting larger tax liabilities in April, did not spend the additional income to help the economy grow
Ricardian View of Debt: Burden
Parents learning that debt operates as a negative future transfer payment, would not spend as much during their lifetime
Parents save and accumulate assets to pass money on to their children and grand children
Position of the FEDA substantial reduction in long-term prospective deficit will significantly lower long-term inflation expectations
Inflationary financed growth results in increased tax revenues and government spending to cause deficit and inflation
Deficit financed growth increases debt with no real income growth, but higher inflation