Chapter 15 - Deficits and debt. After reading this chapter, you should be able to: Define the terms deficit, surplus, and debt and distinguish between a cyclical deficit and a structural deficit; differentiate between real and nominal deficits and surpluses; explain why the debt needs to be judged relative to assets; describe the historical record for the U.S. deficit and debt.
Introduction: Thinking Like an Economist CHAPTER 15 Deficits and Debt Any government, like any family, can for a year spend a little more than it earns. But you and I know that a continuance of that habit means the poorhouse ―Franklin D. Roosevelt Deficits and Debt 151 Chapter Goals Ø Ø Define the terms deficit, surplus, and debt and distinguish between a cyclical deficit and a structural deficit Differentiate between real and nominal deficits and surpluses Ø Explain why the debt needs to be judged relative to assets Ø Describe the historical record for the U.S deficit and debt 152 Deficits and Debt 151 Defining Deficits and Surpluses Ø A deficit is a shortfall of revenues under payments Ø A surplus is an excess of revenues over payments Ø Ø In the short run, if the economy is below potential, deficits are good because deficits increase expenditures moving output closer to potential Long-run surpluses are good because they provide saving for investment 153 Deficits and Debt 151 Financing the Deficit Ø Ø Ø The government finances its deficits by selling bonds to private individuals and to the central bank Bonds are promises to pay back the money in the future The central bank can print an unlimited amount of money to buy bonds, but printing too much money can cause serious inflation 154 Deficits and Debt 151 Arbitrariness in Defining Surpluses and Deficits Ø Ø Ø Ø Whether a nation has a deficit or surplus depends on what is included as revenues and expenditures There are many ways to measure expenditures and receipts, so there are many ways to measure deficits and surpluses Deficit and surplus figures are summary measures of the financial health of the economy To understand the summary, you must understand the methods that were used to calculate it 155 Deficits and Debt 151 Structural and Cyclical Deficits and Surpluses Ø Ø Ø Many government revenues and expenditures depend on the level of income in the economy Structural deficit is the part of the budget deficit that would exist even if the economy were at its potential level of output Cyclical deficit is the part of the deficit that exists because the economy is operating below its potential level of output 156 Deficits and Debt 151 Structural and Cyclical Deficits and Surpluses Ø There is disagreement about what percentage of a deficit is structural and what percentage is cyclical Ø Actual deficit = structural deficit + cyclical deficit Ø Cyclical deficit = tax rate x (potential – actual output) Ø Structural deficit = actual deficit – cyclical deficit Ø Much of the current deficit is structural and will have to continue to keep the economy where it is today; however, it cannot continue indefinitely 157 Deficits and Debt 151 Nominal and Real Deficits and Surpluses Ø A nominal deficit is the difference between expenditures and receipts Ø A real deficit is the nominal deficit adjusted for inflation Ø Inflation reduces the value of the debt Ø Real deficit = Nominal deficit – (Inflation x Total debt) Ø Lowering the real deficit by inflation is not costless to the government • Persistent inflation becomes built into expectations and causes higher interest rates 158 Deficits and Debt 151 Defining Debt and Assets Ø Ø Ø Ø Debt is accumulated deficits minus accumulated surpluses • Debt is a stock, defined at a point in time Deficits and surpluses are flow concepts, defined for a period of time If a country has more surpluses than deficits, the accumulated surpluses minus accumulated deficits are a part of its assets The U.S Treasury must sell new bonds to pay for a deficit and refinance previously issued bonds as they come due 159 Deficits and Debt 151 Debt Management Ø Ø Ø Debt, as a summary measure of a nation’s financial situation, needs to be judged in relation to a nation’s assets When the government runs a deficit, it might be spending on projects that increase its assets If the assets are valued at more than their costs, then the deficit is making society better off 1510 Deficits and Debt 151 Difference Between Individual and Government Debt The government lives forever; people don’t The government can print money to pay its debt; people can’t Government owes much of its debt to itself (to its own citizens) • Internal debt is government debt owed to other governmental agencies or to its own citizens • External debt is government debt owed to individuals in foreign countries 1511 Deficits and Debt 151 U.S Budget Deficits as Percentage of GDP Deficits as percentage of GDP Deficits and debt relative to GDP provide measures of a country’s ability to pay off a deficit and service its debt 10 -10 -20 -30 1900 1920 1940 1960 1980 2000 2020 1512 151 Deficits and Debt U.S Debt as Percentage of GDP Debt as Percentage of GDP 100 75 50 25 1800 1840 1880 1920 1960 2000 ‘20 1513 Deficits and Debt 151 Chapter Summary Ø A deficit is a shortfall of revenues under payments Ø A surplus is the excess of revenues over payments Ø Debt is accumulated deficits minus accumulated surpluses Ø Deficits and surpluses are summary measures of a budget Ø Ø A cyclical deficit is that part of the deficit that exists because the economy is below or above potential output A structural deficit is that part of a budget deficit that would exist even if the economy were at its potential level of output 1514 Deficits and Debt 151 Chapter Summary Ø A real deficit is a nominal deficit adjusted for the effect of inflation Ø A country’s debt must be judged in relation to its assets Ø Government debt and individual debt differ Ø Ø Deficits, surpluses, and debt should be viewed relative to GDP because this ratio better measures the government’s ability to handle the deficit and pay off the debt Since 2008, the U.S has run significant deficits and the debt-to-GDP ratio has risen to over 100 percent 1515 ... debt 10 -1 0 -2 0 -3 0 1900 1920 1940 1960 1980 2000 2020 15? ?12 151 Deficits and Debt U.S Debt as Percentage of GDP Debt as Percentage of GDP 100 75 50 25 1800 1840 1880 1920 1960 2000 ‘20 15? ?13 Deficits and Debt... off the debt Since 2008, the U.S has run significant deficits and the debt-to-GDP ratio has risen to over 100 percent 15? ?15 ... deficit that would exist even if the economy were at its potential level of output 15? ?14 Deficits and Debt 151 Chapter Summary Ø A real deficit is a nominal deficit adjusted for the effect of inflation