Chapter 32: 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. RooseveltDeficits and DebtCopyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/IrwinChapter GoalsDefine the terms deficit, surplus, and debt and distinguish between a cyclical deficit and a structural deficitDifferentiate between real and nominal deficits and surplusesExplain why the debt needs to be judged relative to assetsDescribe the historical record for the U.S. deficit and debtDefining Deficits and SurplusesA deficit is a shortfall of revenues under paymentsA surplus is an excess of revenues over paymentsIn the short run, if the economy is below potential, deficits are good because deficits increase expenditures moving output closer to potentialLong-run surpluses are good because they provide saving for investmentFinancing the DeficitThe government finances its deficits by selling bonds to private individuals and to the central bankBonds are promises to pay back the money in the futureThe central bank can print an unlimited amount of money to buy bonds, but printing too much money can cause serious inflationArbitrariness in Defining Surpluses and DeficitsWhether a nation has a deficit or surplus depends on what is included as revenues and expendituresThere are many ways to measure expenditures and receipts, so there are many ways to measure deficits and surplusesDeficit 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 itStructural and Cyclical Deficits and SurplusesMany government revenues and expenditures depend on the level of income in the economyStructural deficit is the part of the budget deficit that would exist even if the economy were at its potential level of outputCyclical deficit is the part of the deficit that exists because the economy is operating below its potential level of outputStructural and Cyclical Deficits and SurplusesThere is disagreement about what percentage of a deficit is structural and what percentage is cyclicalActual deficit = structural deficit + cyclical deficitCyclical deficit = tax rate x (potential – actual output)Structural deficit = actual deficit – cyclical deficitMuch of the current deficit is structural and will have to continue to keep the economy where it is today; however, it cannot continue indefinitelyNominal and Real Deficits and SurplusesA nominal deficit is the difference between expenditures and receiptsA real deficit is the nominal deficit adjusted for inflationInflation reduces the value of the debtReal deficit = Nominal deficit – (Inflation x Total debt) Lowering the real deficit by inflation is not costless to the government Persistent inflation becomes built into expectations and causes higher interest ratesDefining Debt and AssetsDebt is accumulated deficits minus accumulated surplusesDebt is a stock, defined at a point in timeDeficits and surpluses are flow concepts, defined for a period of timeIf a country has more surpluses than deficits, the accumulated surpluses minus accumulated deficits are a part of its assetsThe U.S. Treasury must sell new bonds to pay for a deficit and refinance previously issued bonds as they come dueDebt ManagementDebt, as a summary measure of a nation’s financial situation, needs to be judged in relation to a nation’s assetsWhen the government runs a deficit, it might be spending on projects that increase its assetsIf the assets are valued at more than their costs, then the deficit is making society better offDifference Between Individual and Government DebtThe government lives forever; people don’tThe government can print money to pay its debt; people can’tGovernment 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 citizensExternal debt is government debt owed to individuals in foreign countriesU.S. Budget Deficits as Percentage of GDPDeficits as percentage of GDP1900 1920 1940 1960 1980 2000 2020100-10-20-30Deficits and debt relative to GDP provide measures of a country’s ability to pay off a deficit and service its debtU.S. Debt as Percentage of GDPDebt as Percentage of GDP1800 1840 1880 1920 1960 2000 ‘20100755025Chapter Summary A deficit is a shortfall of revenues under payments A surplus is the excess of revenues over payments Debt is accumulated deficits minus accumulated surplusesDeficits and surpluses are summary measures of a budget A cyclical deficit is that part of the deficit that exists because the economy is below or above potential outputA structural deficit is that part of a budget deficit that would exist even if the economy were at its potential level of outputChapter Summary A real deficit is a nominal deficit adjusted for the effect of inflationA country’s debt must be judged in relation to its assetsGovernment debt and individual debt differDeficits, 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 debtSince 2008, the U.S. has run significant deficits and the debt-to-GDP ratio has risen to over 100 percent