Chapter 14 Deficit Spending and The Public Debt. Slide 14-2 Introduction A government budget is in deficit when spending exceeds receipts. When the U.S

Chapter 14

Deficit Spending and The Public Debt

Slide 14-2

Introduction

A government budget is in deficit when spending exceeds receipts.

When the U.S. federal government runs a budget deficit, other countries tend to experience deficits as well. Why does

this correlation exist?

Slide 14-3

Explain how federal government budget deficits occur

Define the public debt and understand alternative measures of the public debt

Evaluate circumstances under which the public debt could be a burden to future generations

Learning Objectives

Slide 14-4

Learning Objectives

Discuss why the federal budget deficit might be measured incorrectly

Analyze the macroeconomic effects of government budget deficits

Describe possible ways to reduce the government budget deficit

Slide 14-5

Public Deficits and Debts

Government Finance

Evaluating the Rising Public Debt

Federal Budget Deficits in An Open Economy

Growing U.S. Government Deficits

Chapter Outline

Slide 14-6

Did You Know That...

Throughout the rest of this decade, the U.S. federal government expects to run annual budget deficits?

The relationship between budget deficits and macroeconomic performance is somewhat elusive?

Slide 14-7


A government budget deficit

– Exists if the government spends more than it receives in taxes during a given period of time

– Is financed by the selling of government securities (bonds)

Slide 14-8


The federal deficit is a flow variable, one defined for a specific period of time, usually one year

Slide 14-9


If spending equals receipts, the budget is balanced.

If receipts exceed spending, the government is running a budget surplus.

Slide 14-10


The public debt

– A stock variable

– The total value of all outstanding government securities

Slide 14-11

Government Finance

Since 1940, the U.S. federal government has operated with a budget surplus in 13 years.

In all other years, the shortfall of tax revenues below expenditures has been financed with borrowing.

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Government Finance

Figure 14-1

Slide 14-13


Some government bonds are held by government agencies

– In this case, the funds are owed from one branch of the federal government to another

– To arrive at the net public debt, we subtract interagency borrowings from the gross public debt

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Tax revenues tend to be stagnant during times of slow economic growth.

Tax revenues grow more quickly when overall growth enhances incomes.

As long as spending exceeds revenues, the budget deficit will persist.

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Table 14-1

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The government must pay interest on the public debt outstanding.

The level of these payments depends on the market interest rate.

Interest payments as a percentage of GDP are likely to rise in the future.

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As more of the public debt is held by foreigners, then the amount of interest to be paid outside the U.S. increases.

The presence of the debt may place a burden on future generations.

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If the economy is already at full employment, then further provision of government goods will crowd out some private goods.

Deficit spending may raise interest rates, which in turn will discourage capital formation in the private sector.

Slide 14-19


Burdens on Future Generations:

– Crowding out then may place a burden on future generations by dampening the rate of economic growth

– Taxes may be increased in the long term to retire the debt

Slide 14-20

Policy Example:Jefferson and Hamilton on the Public Debt

Jefferson argued that it was unfair to place the burden of public debt on future generations.

He favored an annually balanced government budget.

Slide 14-21

Policy Example:Jefferson and Hamilton on the Public Debt

Alexander Hamilton, the first U.S. Treasury Secretary, argued that a nation which handled a debt responsibly could build a reputation for creditworthiness.

He concluded that there could be a blessing in a national debt that was not excessive and was repaid on time.

Slide 14-22

Is there anything positive about the public debt?

– While the debt in and of itself may not offer a benefit to our economy, the government expenditures incurred in creating it provide goods and services that are needed.


Slide 14-23

Is there a connection between the U.S. trade deficit and the federal government budget deficit?

A trade deficit exists when the value of imports exceeds the value of exports.

There is a statistical correlation between the two.


Slide 14-24


Figure 14-4

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As the government borrows funds to finance the deficit, and domestic private consumption does not decrease, then some of these funds will be borrowed from foreigners.

The interest rate paid on bonds will need to be high enough to attract foreign investors.


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If foreigners are using the dollars they hold to buy U.S. government bonds, then they will have fewer dollars to spend on U.S. exports.

This shows that a U.S. budget deficit can contribute to a trade deficit.

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There is some debate among economists and policymakers as to what should be considered the best measure of the deficit.

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Most businesses use two budgets:

– An operating budget

– A capital budget

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An operating budget includes current outlays for on-going expenses, such as salaries, supplies, utilities, etc.


Slide 14-30

A capital budget includes expenditures on investment items, such as a new building or implementation of new technology.

These are generally items that are expected to have a life of many years.


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For the federal government, items in an operating budget would include Social Security benefits, interest on the public debt, upkeep of national parks, salaries of federal employees, and the costs of operating the IRS.


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Items in the capital budget would include a new aircraft carrier or weapons system, a new federally-funded highway, construction of a dam, and the design of new software to handle the federal payroll.


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Some economists argue that Congress should establish a separate capital budget which would include investment expenditures.

This might give a more accurate reflection of the deficit.


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Even without a distinction drawn between the capital and operating budgets, there is a discrepancy about the true government deficit measure.


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Deficit estimates are produced both by the Office of Management and Budget and by the Congressional Budget Office.

Each estimate is based on a different set of assumptions, and they have names such as the baseline deficit, policy deficit, or on-budget deficit.


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There is also some disagreement as to whether the Social Security surplus should be used to reduce current deficit numbers.

Keep in mind that any one specific deficit measure you hear is based on a definition and a set of assumptions with which others may disagree.


Slide 14-37

Question

– How do higher deficits affect the economy in the short run?

– If the economy is below full employment, the deficit can close the recessionary gap.

– If the economy is already at full employment, the deficit an create an inflationary gap.


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What is the long-run effect?

– In the long run, a higher deficit does not affect the equilibrium level of real GDP.

– The lasting effect of a persistent deficit is to redistribute resources from the private sector to the public sector.

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How could the deficit be reduced?

– Either by increasing taxes or by reducing government spending

– Both of these solutions involve political realities

Slide 14-40

E-Commerce Example:Internet Taxes

Some state governments have considered imposing taxes on internet transactions as a means of supplementing their budget revenues.

Estimates show that, at best, this would cover about 25 percent of deficits experienced at the state level.

Slide 14-41


In considering how expenditures might be reduced, it is important to look at entitlements.

These are federal government payments that are legislated obligations, and cannot be reduced or eliminated.

Entitlements include Social Security, Medicare, and Medicaid.

Slide 14-42

International Policy Example:Unrealized Public Debts

Peter Heller of the International Monetary Fund has devised a measure intended to include the implicit future indebtedness of a country based on its current entitlements.

The fact that a country’s debt appears larger when using this measure shows that there are significant economic burdens ahead in following through on political promises.

Slide 14-43


Entitlements are the largest component of the U.S. federal budget.

To make a significant cut in expenditures, entitlement programs would have to be revised.

What are the political costs of reducing Social Security and Medicare benefits?

Slide 14-44

Issues and Applications:International Cycles in Deficits

Among the nations of Canada, France, Germany, the U.K. and the U.S., changes in the size of federal budget deficits seem to be correlated.

In part, this is because the business cycles of all these economies are closely aligned.

Slide 14-45

Issues and Applications:International Cycles in Deficits

Also, this correlation occurs because the need for military spending by each nation is determined by outside factors that affect all countries at the same time.

And further, stock market trends that are internationally correlated affect the amount of capital gains tax that can be collected by each federal treasury.

Slide 14-46

Summary Discussion of Learning Objectives

Federal government budget deficits:

– The U.S. federal government operated with a surplus from 1998 through 2001, but it returned to a deficit condition in 2002.

The public debt:

– Total value of all government bonds outstanding

– Net public debt as a share of GDP is 35 percent

Slide 14-47


How the public debt might prove a burden to future generations:– Higher taxes will reduce private consumption– Crowding out could reduce economic growth

Why the federal budget deficit might be incorrectly measured– No distinction between capital expenses and

operating expenses

– Each estimate is based on a set of assumptions

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The macroeconomic effects of government budget deficits:

– In the short run, a deficit can close a recessionary gap or cause an inflationary gap.

– The long run effect is to shift resources from the private sector to the public sector.

Slide 14-49


Possible ways to reduce the government budget deficit:

– Increase taxes

– Reduce expenditures by revising the terms of entitlement programs

End of Chapter 14Deficit Spending and The Public Debt

Documents

Chapter 14 Deficit Spending and The Public Debt. Slide 14-2 Introduction A government budget is in deficit when spending exceeds receipts. When the U.S