Chapter 12 Econ
National debt
Accumulated debt of federal government
Economic growth
Although future generations may benefit from current government spending, they also may be adversely effected by today's opportunity costs. - If federal deficits and debt servicing requirements crowd out private investment, the rate of economic growth will slow, leaving future generations with less productive capacity
Budget deficits
Amount by which government spending exceeds government revenue in a given time period Budget deficit = government spending - tax revenues
Debt ceiling
An explicit, legislated limit on the amount of outstanding national debt - A debt ceiling can be used either to stop accumulation of debt or to force te federal gov to reduce the accumulated debt
Liability
An obligation to make a future payment; debt
Why is the structural budget important?
By distinguishing between the structural budget and the actual budget, we can evaluate fiscal policy more accurately. Only changes in the structural deficit are relevant. - Fiscal stimulus is measured by an increase in the structural deficit (or shrinkage in the structural surplus) - Fiscal restraint is gauged by a decrease in the structural deficit (or increase in the structural surplus)
Can the budget be perpetually balanced?
Congress couldn't balance the federal budget every year even if it wanted to - Congress does not have as much control over revenues and spending as people assume. Thus, deficits or surpluses are not necessarily the result of fiscal policy decisions.
Fiscal stimulus
Tax cuts or spending hikes intended to increase (shift) aggregate demand
Fiscal restraint
Tax hikes or spending cuts intended to reduce (shift) aggregate demand
Fiscal year
The 12 month period used for accounting purposes; begins October 1 for the federal government
Debt service
The interest required to be paid each year on outstanding debt - These interest payments force the government to reduce outlays for other purposes or to finance a larger budget each year. In this respect, interest payments restrict the government's ability to balance the budget or fund other public-sector activities - Most debt servicing is simply a redistribution if ncome from taxpayers to bondholders (bc mostly internal debt, so interest payments are paid to Americans) Interest payments themselves have virtually no opportunity cost
Refinancing
The issuing of new debt in payment of debt issued earlier
Optimal mix of output
The most desirable combination of output attainable with existing resources, technology, and social values - The whole debate about the burden of debt is really an argument about the optimal mix of output (public vs. private)
Deficit spending
The use of borrowed funds to finance government expenditures that exceed tax revenues
Fiscal Policy
The use of government taxes and spending to alter macroeconomic outcomes
External debt
U.S. government debt (Treasury bonds) held by foreign households and institutions
Assets
Anything having exchange value in the marketplace; wealth
Economic effects of deficits
If the government borrows funds to finance deficits, the availability of funds for private sector spending may be reduced (crowding out) - If crowding out occurs, the increase in government expenditure will be at least partially offset by reductions in consumption and investment - If the government were operating at full employment, crowding out would be inevitable. At full employment, we'd be on the production possibilities curve, using all available resources. Remember: additional government spending can occur only if private sector purchases are reduced (so, crowding out implies less private sector output) - Tax cuts also have a crowding out effect, At the PPC limit, added consumption forces cutbacks in either investment or government services - Basically, the risk of crowding out is greater the cider the economy is to full employment. This implies that deficits are less appropriate at high levels of employment but more appropriate at low levels of employment
History of budget deficits
In 2008, the government ran a deficit of 459 billion (largest one in over 30 years). However, this record was shattered when in 2009 we had a deficit of 1.8 trillion. - Budget deficits have been common. In fact, the few years (1998-2001) in which the government ran a budget surplus were a rare departure from a historical pattern
Keynesian theory
Keynesian theory highlights the potential of fiscal policy to solve our macro problems. The guidelines are simple: - Use fiscal stimulus--stepped-up government spending, tax cuts, increased transfers--to eliminate unemployment - Use fiscal restraint--less spending, tax hikes, reduced transfers--to keep inflation under control From this perspective, the federal budget is a key policy tool for controlling the economy
Cyclical sensitivity
Like crowding out, the extent of crowding in depends on the state of the economy. In a recession, a surplus-induced decline in interest rates isn't likely to stimulate much spending. If consumer and investor confidence are low, even a surplus-financed tax cut might not lift private sector spending much
Automatic stabilizers
Most of the uncontrollable line items in the federal budget have another characteristic that directly affects budget deficits: Their value changes with economic conditions - Ex. Unemployment insurance expenditure goes up when more people are unemployed. In 2002, many people lost their jobs and unemployment rose by $17 billion. This spending increase was not a result of any policy decision, it was just an increase in job loss. In other words, an automatic spending increase rather than a discretionary spending increase.
Income transfers
Payments to individuals for which no current goods or services are exchanged, such as social security, welfare, unemployment benefits - Outlays for unemployment compensation and welfare benefits increase when the economy goes into recession. This is exactly the kind of fiscal policy that Keynes advocated. The increase in income transfers helps offset the income losses due to recession. - Therefore, these increased transfers act as automatic stabilizers--injecting new spending into the circular flow during economic contractions - Conversely, transfer payments decline when the economy is expanding and fewer people qualify for unemployment or welfare benefits. Thus, no one has to pull the fical policy level to inject more or less entitlement spending into the circular flow, much of it happens automatically
Treasury bonds
Promissory notes (IOUs) issued by the U.S. treasury - The total stick of all outstanding bonds represents the national debt created by annual deficit flows
Presidents and budget
Reagan: campaigned on a promise to balance the budget, but the 1981-82 recession caused the deficit to soar Bush: added 84 billion to federal deficit bc unemployment rate soared Clinton: increased discretionary spending in the first 2 years, the annual budget deficit shrank by over $90 billion (due to automatic stabilizers after unemployment fell). Produced the first surplus in a generation Bush: also shrunk the deficit Obama: The recession of 2008-9 reversed favorable trends. Federal deficit was increasing. This was a cyclical deficit
Keynesian view
What made the budget deficits of 2003-2009 so remarkable was not only their absolute size but also their sudden emergence after a brief string of budget surpluses (1998-2001) - Keynes wouldn't be too surprised by this, he would think it's just a product of countercyclical fiscal policy. - Deficits can easily arise when gov uses fiscal stimulus to increase aggregate demand, just as fiscal restraint may cause budget surplus - Keynes thought the goal of the macro policy is not to balance the budget but to balance the economy (at full employment). If a budget deficit or surplus is needed to shift AD to the desired equilibrium, then so be it - In Keynes view, a balanced budget would only be desirable if all the other injections and leakages were in balance and the economy was in full employment equilibrium
Who owns the debt
When the U.S. government borrows money, it issues bonds. Those bonds are a liability for the federal government since it must later repay the borrowed funds. But those same bonds are an asset to the people who hold them. Bondholders have a claim to future repayment. They can even concert that claim into cash by selling their bonds in the bond market. - Therefore, national debt creates as much wealth (for bondholders) as liabilities (for the U.S. treasury). Neither money nor any form of wealth disappears when the government borrows money.
Economic effects of surpluses
When the government takes in more than it can spend, it adds to leakage in the circular flow. There are four potential uses for a budget surplus 1. Spend it on goods and services 2. Cut taxes 3. Increase income transfers 4. Pay off old debt (save it)
Repayment
Won't future generations have to pay interest on the debts we incur today? And might they have to pay off some debt? - The collection of taxes and processing of interest payments absorb few resources
Crowding out
A reduction in private sector borrowing (and spending) caused by increased government borrowing
Interest Rate Movements
Although the production possibilities curve illustrates the inevitability of crowding out at full employment, it doesn't explain how the crowding out occurs. - Typically, the mechanism that enforces crowding out is the rate of interest. When the government borrows more funds to finance larger deficits, it puts pressure on financial markets. That added pressure may cause interest rates to rise. If they do, households will be less eager to borrow more money to buy cars, houses, and other debt-financed products. Businesses will also be less eager to borrow and invest. Thus, rising interest rates are both a symptom and a cause of crowding out - Rising interest rates may also crowd out government spending in the wake of tax cuts. As interest rates rise, government borrowing costs rise as well. These higher interest rates leave less room in government budgets for financing new projects
Budget surplus
An excess of government revenues over government expenditures in a given time period
Deficit ceiling
An explicit, legislated limitation on the size of the budget deficit - A deficit ceiling of 0 compels a balanced budget
Crowding in
An increase in private-sector borrowing (and spending) caused by decreased government borrowing - The 4th option for surplus (pay off more debt). If the U.S. pays off some of its accumulated debt, households that were holding that debt (government bonds) will end up with more money. If they use that money to buy goods and services, then private sector output will expand - Even people who haven't lent any money to the government will benefit from the debt reduction. When the government reduces its level of borrowing, it takes the pressure off market interest rates. As interest rates drop, consumers will be more willing and able to purchase big-ticket items such as cars, appliances, and houses, thus changing the mix of output in favor of private-sector production
Discretionary fiscal spending
Those elements of the federal budget not determine by past legislative or executive commitments
Budget balance
Total budget balance = cyclical balance + structural balance - The cyclical portion of the budget balance reflects the impact of the business cycle on federal tax revenues and spending - The structural deficit reflects fiscal policy decisions. Rather than comparing actual outlays to actual receipts, the structural deficit compares that outlets and receipts that would occur if the economy were at full employment Thus, part of the deficit arises from cyclical changes in the economy, the rest is a result of discretionary fiscal policy
Internal debt
U.S. government debt (Treasury bonds) held by U.S. households and institutions - Majority of our debt is internal debt
Budget Surpluses and Deficits
Use of the budget to stabilize the economy implies that federal expenditures and receipts won't always be equal - In a recession, the government has sound reasons both to cut taxes and to increase its own spending simultaneously. However, if it does both, the federal government will throw its budget out of balance. This practice is called deficit spending, a situation in which the government borrows funds to pay for spending that exceeds tax revenues. - The size of the resulting budget deficit is equal to the difference between expenditures and receipts
The accumulation of debt through the years
- The Continental Congress needed to borrow money in 1777 to continue fighting the Revolutionary War. The CC tried to raise tax revenues and even printed new money. However, it was not enough. To acquire needed supplies, the CC plunged the nation into debt by issuing bonds - The U.S. began accumulating debt as soon as independence was declared. By 1783, the U.S. borrowed $8 million from France and $250,000 from Spain. During the period 1890-1812, the U.S. often incurred debt but typically repaid it quickly. However, the War of 1812 caused a massive increase in national debt (129 million) - 1835-6 debt free! After the war of 1812, the U.S. government used recurrent surpluses to repay its debt The Mexican-American War (1846-1848) necessitated a sudden increase in federal spending, but the debt was pared down in the next decade. Then the Civil War broke out. By the end of the Civil War, the North owed over $2.6 billion, or approximately half its national income - The Spanish-American War also increased debt. However, all prior debt was dwarfed by WWI The most explosive jump in national debt occurred during WW2, when the gov had to mobilize all available resources. Rather than raise taxes, the U.S. gov restricted the availability of consumer goods. The U.S. then encouraged people to give their idle funds to war bonds - During the 1980s, the debt jumped again (not war related, originated in recessions, massive tax cuts, and increased defense spending) - The early 1990s also saw increased debt. The recession killed any change of achieving smaller defcits. Clinted reduced structutral deficit by raising taxes, but stull hige debt. - In 2000, after a couple of years of budget surplus, the accumulated debt still exceeded 5.6 trillion. Then Bush tax cuts and defense buildup kicked in, increasing the structural deficit.
Discretionary vs. automatic spending
At the beginning of each year, the president and congress put together a budget blueprint for the next fiscal year (FY) - Most budget line items reflect commitments made in earlier years (and there's little that either the president or congress can do to alter these expenditures) - To a large extent, current revenues and expenditures are the result of decisions made in prior years. Thus, much of a year's budget is considered "uncontrollable" - At present "uncontrollables" account for 80% of the federal budget. This leaves only 20% for discretionary fiscal spending - In recent years, rising interest payments and increasing entitlements (social security, medicare, service pensions, etc) have reduced the discretionary share of the budget even further. This means that the potential for changing the budget outlays in any year is much smaller than it might first appear. - Yet, the ability to change tax or spending levels is the force behind Keynesian fiscal policy (the essence of fiscal restraint and fiscal stimulus). If most of the budget is uncontrollable, those policy tools are less effective
External debt implications
External financing allows us to get more public sector goods without cutting back on private sector production (pushes us outside PPC) - As long as outsiders are willing to hold U.S. bonds, external financing imposes no real cost. No goods or services are given up to pay for additional output received - However, at some point, foreign investors are gonna want to collect their bills. To do this, they'll cash in (sell) their bonds, then use proceeds to buy U.S. goods and services
Automatic stabilizer
Federal expenditure or revenue item that automatically responds countercyclically to changes in national income, like unemployment benefits, income taxes - Progressive income taxes are particularly effective stabilizers, as they siphon off increasing proportions of purchasing power when incomes are rising and decreasing proportions when AD and output are falling
Structural deficit
Federal revenues at full employment minus expenditures at full employment under prevailing fiscal policy
How much does the interest rate rise?
How much interest rates rise depends on how close the economy is to its productive capacity. If there is a lot of excess capacity, interest-rate induced crowding out isn't likely. However, as capacity is approached, interest rates and crowding out are both likely to increase.
Ownership of debt breakdown
The largest bondholder is the U.S. gov itself: federal agencies, social security, and state/local governments hold almost half outstanding treasury bonds - Private sector holds only 17% - Much of this private wealth is held indirectly by baks, insurance companies, corporations. All of this wealth is ultimaltey owned by the people who have deposits at the bank or in money market funds, who own stock in corporations, or who are insured by companies that hold treasury bonds. - Thus, U.S. households hold about ⅙ of the national debt, either directly or indirectly - Foreigners hold 28%
Opportunity cost
The most desired goods and services that are forgone in order to obtain something else - Even if crowding out does occur, that doesn't mean that deficits are necessarily too big. Crowding out simply reminds us that there's an opportunity cost to government spending - We have to decide whether the private-sector output crowded out by government expenditure is more or less desirable than the increased public-sector output President opinions - Clinted: gov expenditure on education, training, and infrastructure was a public investment - Bush: preferred a mix of output that included less public sector and more private sector - Obama: similar to Clinton
Cyclical deficit
The portion of the budget balance attributable to short run changes in economic conditions - The cyclical deficit widens when GDP growth slows or inflation decreases - The cyclical deficit shrinks when GDP growth accelerates or inflation increases
Burden of debt
The true burden of the debt is the opportunity cost (crowding out) of deficit-financed government activity. Also the primary burden of the debt is incurred when the deft-finaned activity takes place (not really the future generations). If the entire military upgrade is completed this year, what costs are borne next year? None. The land, labor, capital can be used for whatever purpose. Government Purchases - Suppose Congress decides to upgrade our naval forces and borrows $10 million. What is the opportunity cost? The land, labor, and capital used to upgrade the fleet can;t be used to produce something else. Key note here is the economic cost of naval upgrade is unaffected by the method of government finance Transfer payments - Suppose the gov't uses debt financing to pay for increased transfer payments rather than purchase of real goods and services. What would be the burden in this case? Basically nothing