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Transcript of Chapter 13: Government Borrowing 13 - 1 Chapter 13 Government Borrowing Copyright © 2009 by The...
Chapter 13: Government Borrowing
13 - 1
Chapter 13
Government Borrowing
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Chapter 13: Government Borrowing
13 - 2
Introduction
Deficit versus debt
The burden of debt
U.S. deficits, debt, and interest during the past half century
Inflation, debt, and deficits
The long-term budget outlook for the U.S.
Chapter 13: Government Borrowing
13 - 3
• Spending minus taxes in a given year
Deficit
• A flow that occurs during a period of time – one year
• The cumulative result of the deficits in prior years
Deficit versus Debt
Debt
• A stock that is measured at a point in time
Chapter 13: Government Borrowing
13 - 4
• This does not mean that all borrowing should be avoided
• Individuals, firms, and government are justified to borrow for long-lived productive assets
If the government defaults on loans, then…
Common Sense Concern about Excessive Borrowing
• Creditors may become wary
… excessive borrowing today means heavy payments to creditors tomorrow.
• There may be increased taxes or a cut in spending
• Inflation may occur if the government prints money
Chapter 13: Government Borrowing
13 - 5
• Children are not legally responsible for their parents’ borrowing
The burden of family borrowing
• In some cases, parents’ borrowing imposes a burden on children
The Burden of the Debt
The burden of government borrowing
• Government borrowing shifts the burden of today’s government spending from today’s taxpayers to tomorrow’s taxpayers
Chapter 13: Government Borrowing
13 - 6
Borrowing is inappropriate when government spending doesn’t benefit tomorrow’s taxpayers.
It depends.
• Current expenditures
Capital Expenditures
Is it fair to shift the burden of today’s government spending?
Borrowing is appropriate when government spending does benefit tomorrow’s taxpayers.
• Capital expenditures
Chapter 13: Government Borrowing
13 - 7
• r increases
Government Borrowing, Interest Rates, and the Crowding Out of Investment
• The government increases borrowing to finance spending
• Government borrowing crowds out private investment
Interest Rate (r)
D
S
Loanable Funds (F)
Figure 13.1
r0
D’
r1
F0 F1
Chapter 13: Government Borrowing
13 - 8
Disciplining Politicians with a Balanced Budget Rule
Spending must be entirely financed by tax revenue.
• The prohibition on borrowing and printing money
• The problem is that this rule may make a recession worse• FEBAR compared to NUBAR
An always balanced budget rule
• Politicians and citizens naturally demand excessive spending
• A balanced budget leads to optimal spending
Chapter 13: Government Borrowing
13 - 9
A planned balanced budget for next year is based on an estimate if next year’s unemployment rate is normal.
• Would provide discipline
A Normal-Unemployment Balanced Budget Rule
NUBAR
Questions
• How would it be implemented?
• Would avoid worsening a recession
• How would it be enforced?
• What about a recession or a war?
Chapter 13: Government Borrowing
13 - 10
Suppose $110,000 is promised next year and $100,000 of taxes is raised this year.
• It depends on the interest rate.
Fiscal Imbalance
Examples of long-term
fiscal imbalance
• Medicare
Is the $100,000 enough?
• Social Security
• Federal debt
The present value of future promised benefits( ) The present value of
future assigned taxes( )=
Chapter 13: Government Borrowing
13 - 11
Generational Accounting
…focuses on how each generation fares with respect to government taxing and spending
• Some generations get a better or worse deal from government taxing and spending
Examples
• First public schools
• Social Security
The present value of benefits it receives( ) The present value
of taxes it pays( )=
Chapter 13: Government Borrowing
13 - 12
Table 13.1
U.S. Treasury debt held by the public (U.S. net debt) $5 trillion
U.S. Treasury debt held by the public – domestic $2.8 trillion
U.S. Treasury debt held by the public – foreign $2.2 trillion
U.S. Treasury debt held by the public – China, Japan, U.K. $1.2 trillion
U.S. Treasury debt held by the public – All other countries $1 trillion
U.S. Treasury debt held by U.S. government (including SS) $4 trillion
Total U.S. Treasure debt (U.S. gross debt) $9 trillion
U.S. GDP $14 trillion
U.S. Treasury debt held by the public as a % of GDP 37%
Total U.S. Treasury debt as a % of GDP 63%
U.S. Treasury Debt Held by the Public and by U.S. Government Agencies
Chapter 13: Government Borrowing
13 - 13
Table 13.2
1980 1993 2001 2007
U.S. net debt as a % of GDP 26% 49% 33% 37%
Interest rate on U.S. Treasury bonds 7.3% 6.1% 6% 4.6%
Net interest as a % of GDP 1.9% 3% 2% 1.7%
Revenue as a % of GDP 19% 17.5% 19.8% 18.8%
Net interest as a % of revenue 10% 17% 10% 9%
% of revenue available to finance programs 90% 83% 90% 91%
The Interest Burden of the U.S. Treasury
• Net debt as a percent of GDP
• Bond interest rate
Consequences for the interest burden
Source: CBO, The Budget and Economic Outlook: Fiscal Years 2008 to 2018 (Jan. 2008), Table F-2 and F-6
Chapter 13: Government Borrowing
13 - 14
Table 13.3
g = 5% f = 5% r = 5%
Year Debt GDP b Deficit Interest i
0 $5,000 $10,000 50% $500 $250 2.5%
1 $5,500 $10,500 52.4% $525 $275 2.62%
2 $6,025 $11,025 54.6% $551.25 $301.25 2.73%
Long Run 100% 5%
The Deficit, Debt, and Interest as a Percent of GDP
b* = f/g
i* = rb* = r(f/g)
Chapter 13: Government Borrowing
13 - 15
Inflation, Debt, and Deficits
Real surplus
Real deficit
= (Taxes) – (Spending) + (the reduction in the real value of the debt due to inflation)
= (Nominal surplus) + (the reduction in the real value of the debt due to inflation)
= (Spending) – (Taxes) – (the reduction in the real value of the debt due to inflation)
= (Nominal Deficit) – (the reduction in the real value of the debt due to inflation)
Chapter 13: Government Borrowing
13 - 16
Generating Inflation
Combined fiscal-monetary stimulates the economy
• Congress and the president have the power to borrow money from the public
• The Federal Reserve has the power to inject money into the economy
Separation of powers
• Which raises aggregate demand for goods and services above supply
• Which causes prices to rise – inflation
Chapter 13: Government Borrowing
13 - 17
Generating Inflation
• Excess demand raises inflation
Deficits and inflation
• Deficits can cause inflation
• Deficits do not have to generate inflation
Do deficits directly cause inflation?
• Deficient demand reduces inflation
Chapter 13: Government Borrowing
13 - 18
The Long-Term Budget Outlook for the U.S.
Figure 1.11% of GDP
24%
23%
22%
20%
19%
18%
1965 1970 1975 1980 1985 1990 1995 2000 2005 Year
Federal Spending
21%
17%
16%
Federal Taxes
• Average federal spending ~ 20% of GDP
• Average federal revenue ~ 18% of GDP
Chapter 13: Government Borrowing
13 - 19
The Long-Term Budget Outlook for the U.S.
Figure 1.12
% of GDP
50%
45%
40%
35%
30%
25%
1965 1970 1975 1980 1985 1990 1995 2000 2005 Year
Federal Debt
• Average federal deficit ~ 2% of GDP
Chapter 13: Government Borrowing
13 - 20
Summary
Deficit versus debt
The burden of debt
U.S. deficits, debt, and interest during the past half century
Inflation, debt, and deficits
The long-term budget outlook for the U.S.