View
217
Download
2
Category
Tags:
Preview:
Citation preview
© 2003 McGraw-Hill Ryerson Limited.
Politics, Surpluses, Politics, Surpluses, Deficits, and DebtDeficits, and Debt
Chapter 12Chapter 12
12 - 2
© 2003 McGraw-Hill Ryerson Limited.
IntroductionIntroduction
After having run budget deficits for many decades, in 1997 the federal government began to run budget surpluses.
12 - 3
© 2003 McGraw-Hill Ryerson Limited.
IntroductionIntroduction
In the long-run framework, surpluses are good because they provide additional saving for an economy.
Deficits are bad because they reduce saving, growth, and income.
12 - 4
© 2003 McGraw-Hill Ryerson Limited.
IntroductionIntroduction
In a short-run framework, the view of surpluses and deficits depends on the state of the economy relative to its potential income.
12 - 5
© 2003 McGraw-Hill Ryerson Limited.
IntroductionIntroduction
If the economy is running below its potential output, deficits are good and surpluses are bad.
Deficits increase expenditures, increasing output by a multiple of that amount.
12 - 6
© 2003 McGraw-Hill Ryerson Limited.
IntroductionIntroduction
Combining the long-and short-run frameworks gives the following policy: Whenever possible, run surpluses, or
at least a balanced budget, to help stimulate long-term growth.
This is especially true when the economy is booming – when it is above its level of potential income.
12 - 7
© 2003 McGraw-Hill Ryerson Limited.
IntroductionIntroduction
The argument for surpluses is weakened, and likely reversed, when the economy falls into a recession.
12 - 8
© 2003 McGraw-Hill Ryerson Limited.
IntroductionIntroduction
At the beginning of 2000 there was a large surplus. The economy was booming. Unemployment was low. There was general agreement that the
economy was closing in on its potential output.
12 - 9
© 2003 McGraw-Hill Ryerson Limited.
IntroductionIntroduction
Both short- and long-term economic frameworks would recommend cutting the national debt.
Instead of doing so, government looked at ways to spend the surplus, either by cutting taxes or by increasing spending.
12 - 10
© 2003 McGraw-Hill Ryerson Limited.
Defining Surpluses and Defining Surpluses and DeficitsDeficits A surplus is an excess of revenues
over payments. A deficit is a shortfall of revenues under
payments. Both are flow concepts.
12 - 11
© 2003 McGraw-Hill Ryerson Limited.
Financing the DeficitFinancing the Deficit
The deficit must be financed. The government finances its deficits by
selling bonds – promises to pay back the money in the future – to private individuals and to the central bank.
12 - 12
© 2003 McGraw-Hill Ryerson Limited.
Financing the DeficitFinancing the Deficit
Since the central bank's IOUs are money, the loans can also be made by printing money.
Potentially, the central bank has an unlimited source of funds.
12 - 13
© 2003 McGraw-Hill Ryerson Limited.
Financing the DeficitFinancing the Deficit
However, printing too much money would trigger inflation which can have a negative effect on the economy.
12 - 14
© 2003 McGraw-Hill Ryerson Limited.
Arbitrariness in Arbitrariness in Defining Surpluses and Defining Surpluses and DeficitsDeficits Defining surpluses and deficits can be
arbitrary.
12 - 15
© 2003 McGraw-Hill Ryerson Limited.
Arbitrariness in Arbitrariness in Defining Surpluses and Defining Surpluses and DeficitsDeficits Whether or not a nation has a deficit
depends on what is included as a revenue and what is included as an expenditure.
This accounting issue is central to the debate about whether we should be concerned about a deficit.
12 - 16
© 2003 McGraw-Hill Ryerson Limited.
Arbitrariness in Arbitrariness in Defining Surpluses and Defining Surpluses and DeficitsDeficits The Retirement Income system is
based on promises to pay. Retirement Income System - social
insurance programs that provide financial benefits to the elderly and disabled and to their eligible dependents and/or survivors.
12 - 17
© 2003 McGraw-Hill Ryerson Limited.
Arbitrariness in Arbitrariness in Defining Surpluses and Defining Surpluses and DeficitsDeficits The way these programs is accounted
for plays an important role in whether there is a budget deficit or surplus.
12 - 18
© 2003 McGraw-Hill Ryerson Limited.
Surpluses and Deficits Surpluses and Deficits As Summary MeasuresAs Summary Measures As a summary, a surplus or deficit figure
reduces a complicated set of accounting relationships down to a single figure.
12 - 19
© 2003 McGraw-Hill Ryerson Limited.
Surpluses and Deficits Surpluses and Deficits As Summary MeasuresAs Summary Measures Deficit need not matter - what is
important is the health of the economy.
12 - 20
© 2003 McGraw-Hill Ryerson Limited.
Nominal and Real Nominal and Real Surpluses and DeficitsSurpluses and Deficits A nominal deficit is the deficit
determined by looking at the difference between expenditures and receipts.
A real deficit is the nominal deficit adjusted for inflation.
12 - 21
© 2003 McGraw-Hill Ryerson Limited.
Nominal and Real Nominal and Real Surpluses and DeficitsSurpluses and Deficits Inflation wipes out debt (accumulated
deficits less accumulated surpluses). The larger the debt and the larger the
inflation, the more debt will be eliminated by inflation.
12 - 22
© 2003 McGraw-Hill Ryerson Limited.
Nominal and Real Nominal and Real Surpluses and DeficitsSurpluses and Deficits If inflation is wiping out debt, and the
deficit is equal to the increases in debt from one year to the next, inflation also affects the deficit.
12 - 23
© 2003 McGraw-Hill Ryerson Limited.
Nominal and Real Nominal and Real Surpluses and DeficitsSurpluses and Deficits The real deficit is calculated by
adjusting the nominal deficit for inflation.
real deficit = nominal deficit - (inflation x total debt)
12 - 24
© 2003 McGraw-Hill Ryerson Limited.
Nominal and Real Nominal and Real Surpluses and DeficitsSurpluses and Deficits The lowering of the real deficit by
inflation is not costless to the government.
Persistent inflation becomes built into expectations and causes higher interest rates.
12 - 25
© 2003 McGraw-Hill Ryerson Limited.
Structural and Passive Structural and Passive Surpluses and DeficitsSurpluses and Deficits It is important to make a distinction
between structural and passive deficits. Not all government expenditures are
independent of the level of income in the economy.
12 - 26
© 2003 McGraw-Hill Ryerson Limited.
Structural and Passive Structural and Passive Surpluses and DeficitsSurpluses and Deficits There is a difference between a budget
deficit being used as a policy instrument to affect the economy and a budget deficit that is the result of income deviating from its potential.
12 - 27
© 2003 McGraw-Hill Ryerson Limited.
Structural and Passive Structural and Passive Surpluses and DeficitsSurpluses and Deficits A structural deficit or surplus is the
part of the budget deficit or surplus that would exist even if the economy were at its potential level of income.
12 - 28
© 2003 McGraw-Hill Ryerson Limited.
Structural and Passive Structural and Passive Surpluses and DeficitsSurpluses and Deficits A passive deficit or surplus is the part
of the deficit or surplus that exists because the economy is operating below or above its potential level of output.
The passive deficit is also known as the cyclical deficit.
12 - 29
© 2003 McGraw-Hill Ryerson Limited.
Structural and Passive Structural and Passive Surpluses and DeficitsSurpluses and Deficits When an economy is operating above
its potential, it has a passive surplus. If the economy is operating below its
potential, the actual deficit would be larger than the structural deficit.
12 - 30
© 2003 McGraw-Hill Ryerson Limited.
Structural and Passive Structural and Passive Surpluses and DeficitsSurpluses and Deficits There is a significant debate about what
is an economy’s potential income level. There is disagreement about what
percentage of a deficit is structural and what part is passive.
12 - 31
© 2003 McGraw-Hill Ryerson Limited.
The Definition of Debt The Definition of Debt and Assetsand Assets Debt is accumulated deficits minus
accumulated surpluses. Deficits and surpluses are flow
concepts. Debt is a stock concept.
12 - 32
© 2003 McGraw-Hill Ryerson Limited.
Debt ManagementDebt Management
The debt must be managed. The Canadian government must refinance
the bonds that are coming due by selling new bonds, as well as sell new bonds when running a deficit.
12 - 33
© 2003 McGraw-Hill Ryerson Limited.
Debt ManagementDebt Management
In the late 1990s, the federal government ran a budget surplus.
The government retired some of its previously issued bonds by buying them back and did not replace them as they come due.
12 - 34
© 2003 McGraw-Hill Ryerson Limited.
The Need to Judge Debt The Need to Judge Debt Relative to AssetsRelative to Assets Debt needs to be judged relative to
assets. Debt is a summary measure of a
nation’s financial situation. As a summary measure, debt has even
more problems than deficit.
12 - 35
© 2003 McGraw-Hill Ryerson Limited.
The Need to Judge Debt The Need to Judge Debt Relative to AssetsRelative to Assets Debt by itself is only half the picture. The other half of the picture is assets.
12 - 36
© 2003 McGraw-Hill Ryerson Limited.
The Need to Judge Debt The Need to Judge Debt Relative to AssetsRelative to Assets For a government, assets include:
Its skilled work force. Natural resources. Its factories. Its housing stock. Holdings of foreign assets.
12 - 37
© 2003 McGraw-Hill Ryerson Limited.
The buildings and land it owns. A portion of the assets of the people in the
country, since government gets a portion of all earnings of those assets in tax revenue.
The Need to Judge Debt The Need to Judge Debt Relative to AssetsRelative to Assets For a government, assets include:
12 - 38
© 2003 McGraw-Hill Ryerson Limited.
If the assets are valued at more than their costs, then the deficit is making the society better off.
The Need to Judge Debt The Need to Judge Debt Relative to AssetsRelative to Assets When the government runs a deficit, it
might be spending on projects that increase its assets.
12 - 39
© 2003 McGraw-Hill Ryerson Limited.
Arbitrariness in Arbitrariness in Defining Debt and Defining Debt and AssetsAssets Defining debt and assets can be
arbitrary. As was the case with income, revenues,
and deficits, there is no perfect answer as to how assets and debt should be valued.
12 - 40
© 2003 McGraw-Hill Ryerson Limited.
Arbitrariness in Arbitrariness in Defining Debt and Defining Debt and AssetsAssets Even after assets are taken into
account, you still have to be careful when deciding whether or not to be concerned about debt.
12 - 41
© 2003 McGraw-Hill Ryerson Limited.
Arbitrariness in Arbitrariness in Defining Debt and Defining Debt and AssetsAssets The total stock of gross debt can be
broken down into market debt and non-market debt.
Market debt includes marketable bonds, treasury bills and other securities.
Non-market debt includes federal public sector pension liabilities and other federal liabilities.
12 - 42
© 2003 McGraw-Hill Ryerson Limited.
Arbitrariness in Arbitrariness in Defining Debt and Defining Debt and AssetsAssets To calculate debt, we add market debt
and non-market debt, and subtract the value of financial assets held by the government, such as cash, reserves, and loans.
12 - 43
© 2003 McGraw-Hill Ryerson Limited.
Difference Between Difference Between Individual and Individual and Government DebtGovernment Debt Individual and government debt are
different.
12 - 44
© 2003 McGraw-Hill Ryerson Limited.
Government debt is ongoing. Government can print money to pay off its
debt – individuals can’t. Three quarters of government debt is
internal debt – debt owed to other government agencies or to its citizens.
Difference Between Difference Between Individual and Individual and Government DebtGovernment Debt Government debt is different from an
individual’s debt for three reasons:
12 - 45
© 2003 McGraw-Hill Ryerson Limited.
Difference Between Difference Between Individual and Individual and Government DebtGovernment Debt Paying interest on the internal debt
involves a redistribution among citizens of the country, but it does involve a net reduction in income of the average citizen.
12 - 46
© 2003 McGraw-Hill Ryerson Limited.
External debt – government debt owed to individuals in foreign countries.
Difference Between Difference Between Individual and Individual and Government DebtGovernment Debt
External debt is more like an individual’s debt.
12 - 47
© 2003 McGraw-Hill Ryerson Limited.
Government Deficits Government Deficits and Debt: The and Debt: The Historical RecordHistorical Record Most economists do not look at absolute
figures of deficits and debt. They are much more concerned with
deficits and debt relative to GDP.
12 - 48
© 2003 McGraw-Hill Ryerson Limited.
Government Deficits Government Deficits and Debt: The and Debt: The Historical RecordHistorical Record Deficits and debt relative to GDP rose
significantly in the 1970s and 1980s.
In the late 1990s debt started to fall, reaching 50% of GDP in 2001.
12 - 49
© 2003 McGraw-Hill Ryerson Limited.
Canadian Budget Canadian Budget Deficit Relative to GDP, Deficit Relative to GDP, Fig. 12-1a, p 293Fig. 12-1a, p 293
-0.04
-0.02
0
0.02
0.04
0.06
0.08
0.1
0.12
0.14
1961 1971 1981 1991 2001
Years
% f
luctu
ati
on
in
defi
cit
/GD
P
12 - 50
© 2003 McGraw-Hill Ryerson Limited.
Canadian Debt Relative Canadian Debt Relative to GDP, to GDP, Fig. 12-1b, p 293Fig. 12-1b, p 293
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
1961 1971 1981 1991 2001
Years
% f
luc
tua
tio
ns
in
de
bt/
GD
P
12 - 51
© 2003 McGraw-Hill Ryerson Limited.
Government Deficits Government Deficits and Debt: The and Debt: The Historical RecordHistorical Record Economists prefer the “relative to GDP
measurement” because it better measures the government’s ability to handle the deficit and pay off the debt.
The ability to pay off a debt depends on a nation’s productive capacity, the asset side of the equation.
12 - 52
© 2003 McGraw-Hill Ryerson Limited.
The Debt BurdenThe Debt Burden
Decrease of debt/GDP ratio was mainly due to growth in GDP.
There are two ways in which GDP can grow: Through inflation – a rise in nominal,
but not real GDP. Through real growth.
12 - 53
© 2003 McGraw-Hill Ryerson Limited.
The Debt BurdenThe Debt Burden
When GDP grows, the debt the government can reasonable handle also grows.
The economy becomes richer, and, being richer, it can handle more debt.
12 - 54
© 2003 McGraw-Hill Ryerson Limited.
The Debt BurdenThe Debt Burden
Real growth in Canada has averaged about 2.5 to 3.5 percent a year.
This means that Canadian debt can grow at the same rate without increasing the debt/GDP ratio.
12 - 55
© 2003 McGraw-Hill Ryerson Limited.
Debt Relative to Other Debt Relative to Other CountriesCountries Canada has a relatively large debt
burden compared to other advanced economies.
The increasing trend of debt to GDP has been reversed in the 1990s, when government revamped its programs and policies.
12 - 56
© 2003 McGraw-Hill Ryerson Limited.
Debt Relative to Other Debt Relative to Other CountriesCountries There was a structural deficit in Canada
– even at full employment, spending exceeded revenue.
While Canada’s debt is still high, it is much lower than it was in the 1990s.
12 - 57
© 2003 McGraw-Hill Ryerson Limited.
Debt Relative to Other Debt Relative to Other Countries, Countries, Fig. 12-2, p 294Fig. 12-2, p 294
0
20
40
60
80
100
120
Italy Canada Germany France U.S. Japan U.K.
12 - 58
© 2003 McGraw-Hill Ryerson Limited.
Interest Rates and Debt Interest Rates and Debt BurdenBurden Besides the debt relative to GDP
figures, economists are concerned about the interest rate paid on the debt because interest rates affect debt burden.
12 - 59
© 2003 McGraw-Hill Ryerson Limited.
Interest Rates and Debt Interest Rates and Debt BurdenBurden How much of a burden a given amount
of debt imposes depends on the interest rate that must be paid on that debt.
12 - 60
© 2003 McGraw-Hill Ryerson Limited.
Interest Rates and Debt Interest Rates and Debt BurdenBurden The interest rate determines annual
debt service. Annual debt service – the interest rate
on debt times the total debt.
12 - 61
© 2003 McGraw-Hill Ryerson Limited.
Interest Rates and Debt Interest Rates and Debt BurdenBurden Ultimately, the interest payments are
the burden of the debt. That is what people mean when they
say a deficit is burdening future generations.
12 - 62
© 2003 McGraw-Hill Ryerson Limited.
Interest Rates and Debt Interest Rates and Debt BurdenBurden Canada can actually afford more debt
since Canadian government securities are considered to be very safe.
12 - 63
© 2003 McGraw-Hill Ryerson Limited.
Federal Interest Federal Interest Payments Relative to Payments Relative to GDP, GDP, Fig. 12-3, p 295Fig. 12-3, p 295
0
0.01
0.02
0.03
0.04
0.05
0.06
0.07
1961 1971 1981 1991 2001
Years
% f
luctu
ati
on
s o
ut
of
GD
P
12 - 64
© 2003 McGraw-Hill Ryerson Limited.
The Modern Debate The Modern Debate About the SurplusAbout the Surplus The modern debate about the
government budget concerns what to do with the surplus.
12 - 65
© 2003 McGraw-Hill Ryerson Limited.
Why Did the Surpluses Why Did the Surpluses Come About?Come About? Keynesian economics made clear that
deficits could serve a positive function when the economy was below its potential.
This view was never fully accepted by politicians, nor by the public.
12 - 66
© 2003 McGraw-Hill Ryerson Limited.
Why Did the Surpluses Why Did the Surpluses Come About?Come About? The 1980s saw a change in the political
landscape. Politicians were pushing the economy
toward deficits by cutting taxes, and expanding the deficits.
12 - 67
© 2003 McGraw-Hill Ryerson Limited.
Why Did the Surpluses Why Did the Surpluses Come About?Come About? In the 1990s, the federal government
realized it increased its spending to the point it was running a structural deficit.
Even if the economy were operating at the potential output, the budget would be in deficit.
12 - 68
© 2003 McGraw-Hill Ryerson Limited.
Why Did the Surpluses Why Did the Surpluses Come About?Come About? The authorities raised taxes, cut many
social programs and redesigned existing programs.
12 - 69
© 2003 McGraw-Hill Ryerson Limited.
Why Did the Surpluses Why Did the Surpluses Come About?Come About? The surpluses of the late 1990s were
brought about by the unexpected growth of the economy and a low and stable rate of inflation.
Interest rates stayed low, holding down government interest payments.
12 - 70
© 2003 McGraw-Hill Ryerson Limited.
Why Did the Surpluses Why Did the Surpluses Come About?Come About? Expected tax revenue also increased,
and deficit predictions moved in the opposite direction, to surplus predictions.
12 - 71
© 2003 McGraw-Hill Ryerson Limited.
Federal Deficit and Federal Deficit and Debt Are Only Part of Debt Are Only Part of the Picturethe Picture Provinces and municipalities also run
deficits by borrowing to spend in excess of their revenues, and thereby raise the total amount of government debt in the economy.
12 - 72
© 2003 McGraw-Hill Ryerson Limited.
Net Debt: Federal, Net Debt: Federal, Provincial and Local, Provincial and Local, Fig. Fig.
12-4a, p 29812-4a, p 298
0
100000
200000
300000
400000
500000
600000
700000
1977 1980 1983 1986 1989 1992 1995 1998 2001
Federal Net Debt
Provincial Net Debt
Local Net Debt
12 - 73
© 2003 McGraw-Hill Ryerson Limited.
Net Debt: Federal, Net Debt: Federal, Provincial and Local, Provincial and Local, Fig. Fig.
12-4b, p 29812-4b, p 298
-50000
-40000
-30000
-20000
-10000
0
10000
20000
1 2 3 4 5 6 7 8 9 10 11 12 13
Federal Deficit
Provincial and LocalDeficit
12 - 74
© 2003 McGraw-Hill Ryerson Limited.
Federal Deficit and Federal Deficit and Debt Are Only Part of Debt Are Only Part of the Picturethe Picture Net provincial and territorial debt rose
significantly during the 1990s.
The increase in spending by the provinces was partly a response to the federal budget cuts.
“Fiscal responsibility” is the agenda of many newly elected politicians.
12 - 75
© 2003 McGraw-Hill Ryerson Limited.
A Different Type of A Different Type of Crowding OutCrowding Out High government deficits require more
and more borrowing, reducing the capital available to government and private enterprise.
Interests rates increase as a result, and this means that borrowing is more expensive for firms who wish to fund expansion by issuing debt (such as bonds).
12 - 76
© 2003 McGraw-Hill Ryerson Limited.
A Different Type of A Different Type of Crowding OutCrowding Out Private sector investment is crowded
out – higher levels of government spending raise interest rates, which in turn reduce the level of private investment.
12 - 77
© 2003 McGraw-Hill Ryerson Limited.
A Different Type of A Different Type of Crowding OutCrowding Out Increase in government spending
increases interest rates, and appreciates domestic currency.
When domestic currency gains value, exports decrease, and imports rise.
12 - 78
© 2003 McGraw-Hill Ryerson Limited.
Is the Deficit a Good Is the Deficit a Good Measure of the Stance of Measure of the Stance of Fiscal Policy?Fiscal Policy? Can we use deficit to find out if fiscal
policies are becoming more or less expansionary – the stance of fiscal policy?
The answer is NO. Deficit can change as a result of a shift in an autonomous component of demand.
12 - 79
© 2003 McGraw-Hill Ryerson Limited.
Is the Deficit a Good Is the Deficit a Good Measure of the Stance of Measure of the Stance of Fiscal Policy?Fiscal Policy? If autonomous spending (investment, for
example) decreased, deficit would rise because income would fall and reduce tax revenues.
This deficit increase was not a result of expansionary fiscal policy.
12 - 80
© 2003 McGraw-Hill Ryerson Limited.
Is the Deficit a Good Is the Deficit a Good Measure of the Stance of Measure of the Stance of Fiscal Policy?Fiscal Policy? Budget surplus:
BS = T – GG = G0
T = T0 + tY
BS = [T0 - G0] + tY
12 - 81
© 2003 McGraw-Hill Ryerson Limited.
The Budget Surplus The Budget Surplus Function, Function, Fig. 12-5a, p 299Fig. 12-5a, p 299
BS0
Y0
Y10
BS
BS1
BS
Income
12 - 82
© 2003 McGraw-Hill Ryerson Limited.
Is the Deficit a Good Is the Deficit a Good Measure of the Stance of Measure of the Stance of Fiscal Policy?Fiscal Policy? A change in equilibrium income would
affect the budget surplus equation, independent of policy variables (T0,G0 or t).
A better measure of the stance of fiscal policy is the structural deficit.
12 - 83
© 2003 McGraw-Hill Ryerson Limited.
Is the Deficit a Good Is the Deficit a Good Measure of the Stance of Measure of the Stance of Fiscal Policy?Fiscal Policy? Holding income at its potential level, we
can see how changes in fiscal policy affect the budget surplus.
12 - 84
© 2003 McGraw-Hill Ryerson Limited.
The Budget Surplus The Budget Surplus Function, Function, Fig. 12-5b, p 299Fig. 12-5b, p 299
BS0
BS1
Increasein tax shifts BS
Income
BS
0
BS1
BS0
Yp
© 2003 McGraw-Hill Ryerson Limited.
Politics, Surpluses, Politics, Surpluses, Deficits, and DebtDeficits, and Debt
End of Chapter 12End of Chapter 12
Recommended