Download Chapter 16: Government Debt

11/6/2013
Indebtedness of the world’s governments
Country
Chapter 16: Government Debt
CHAPTER 16
Government Debt and Budget Deficits
Ratio of U.S. govt debt to GDP
0.6
Revolutionary
War
Civil War
Country
Gov Debt
(% of GDP)
Japan
173
U.K.
59
Italy
113
Netherlands
55
46
Greece
101
Norway
Belgium
92
Sweden
45
U.S.A.
73
Spain
44
France
73
Finland
40
Portugal
71
Ireland
33
Germany
65
Korea
33
Canada
63
Denmark
28
Austria
63
Australia
14
The U.S. experience in recent years
Early 1980s through early 1990s
 debt-GDP ratio: 25.5% in 1980, 48.9% in 1993
 due to Reagan tax cuts, increases in defense
spending & entitlements
WW2
0.8
(% of GDP)
0
1.2
1.0
Gov Debt
Iraq
War
Early
E
l 1990
1990s th
through
h 2000
 $290b deficit in 1992, $236b surplus in 2000
 debt-GDP ratio fell to 32.5% in 2000
 due to rapid growth, stock market boom, tax
hikes
WW1
0.4
0.2
0.0
1790 1810 1830 1850 1870 1890 1910 1930 1950 1970 1990 2010
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Government Debt and Budget Deficits
The U.S. experience in recent years
The troubling long-term fiscal outlook
Early 2000s
 the return of huge deficits, due to Bush tax cuts,
2001 recession, Iraq war
 The U.S. population is aging.
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 Health care costs are rising.
 Spending on entitlements like
The 2008-2009 recession
 fall in tax revenues
 huge spending increases (bailouts of financial
institutions and auto industry, stimulus package)
Social
S
i lS
Security
it and
dM
Medicare
di
is growing.
 Deficits and the debt are
projected to significantly
increase…
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Government Debt and Budget Deficits
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U.S. government spending on Medicare and
Social Security
Percent of U.S. population age 65+
Percent 23
of pop. 20
actual
Percent 8
of GDP
projected
6
17
4
14
11
2
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CBO projected U.S. federal govt debt in
two scenarios
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2005
2000
1995
1990
1985
1980
1975
1970
1965
1960
0
1955
2050
2040
2030
2020
2010
2000
1990
1980
1970
1960
1950
5
1950
8
Government Debt and Budget Deficits
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Problems measuring the deficit
1. Inflation
300
Percent o
of GDP
2. Capital assets
250
3. Uncounted liabilities
200
pessimistic
scenario
150
4 The business cycle
4.
100
50
optimistic scenario
0
2005 2010 2015 2020 2025 2030 2035 2040 2045 2050
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Government Debt and Budget Deficits
MEASUREMENT PROBLEM 1:
MEASUREMENT PROBLEM 1:
Inflation
Inflation
 Suppose the real debt is constant, which implies a
 Correcting the deficit for inflation can make a huge
zero real deficit.
difference, especially when inflation is high.
 In this case, the nominal debt D grows at the rate
 Example: In 1979,
of inflation:
D/D = 
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nominal deficit = $28 billion
or
D =  D
inflation = 8.6%
 The reported deficit (nominal) is  D
debt = $495 billion
 D = 0.086  $495b = $43b
even though the real deficit is zero.
 Hence, should subtract  D from the reported
real deficit = $28b  $43b = $15b surplus
deficit to correct for inflation.
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MEASUREMENT PROBLEM 2:
MEASUREMENT PROBLEM 3:
Capital Assets
Uncounted liabilities
 Current measure of deficit omits important
 Currently, deficit = change in debt
 Better, capital budgeting:
liabilities of the government:
 future pension payments owed to
deficit = (change in debt)  (change in assets)
current govt workers
 EX: Suppose
pp
g
govt sells an office building
g and
 future Social Security payments
 contingent liabilities, e.g., covering federally
uses the proceeds to pay down the debt.
 under current system, deficit would fall
 under capital budgeting, deficit unchanged,
because fall in debt is offset by a fall in assets.
insured deposits when banks fail
(Hard to attach a dollar value to contingent
liabilities, due to inherent uncertainty.)
 Problem w/ cap budgeting: Determining which
govt expenditures count as capital expenditures.
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Government Debt and Budget Deficits
CASE STUDY:
CASE STUDY:
Accounting for TARP
 Troubled Asset Relief Program (TARP):
Accounting for TARP
 Should the TARP outlays count toward the
 The U.S. Treasury gave money to help
deficit?
 The U.S. Treasury considered TARP outlays to
be expenditures that increased the deficit, and
will consider bank repayments
p y
as revenues that
will reduce the deficit.
 Congressional Budget Office (CBO) counted
the net present value of the program – outlays
minus eventual repayments – adjusted for the
risk of non-repayment. This works out to 25
cents for each dollar spend on TARP.
struggling banks.
 In return, the Treasury became part owner of
the banks
banks, will receive dividends
dividends, will eventually
relinquish ownership when banks repay
principal.
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MEASUREMENT PROBLEM 4:
MEASUREMENT PROBLEM 4:
The business cycle
The business cycle
 The deficit varies over the business cycle due to
 Solution: cyclically adjusted budget deficit
 These are not measurement errors,, but do make
it harder to judge fiscal policy stance.
 E.g., is an observed increase in deficit
due to a downturn or an expansionary shift
in fiscal policy?
Government Debt and Budget Deficits
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(aka “full-employment deficit”) – based on
estimates of what govt spending & revenues
would be if economy were at the natural rates of
output & unemployment
unemployment.
automatic stabilizers (unemployment insurance,
the income tax system).
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The actual and cyclically adjusted
U.S. Federal budget surpluses/deficits
The bottom line
3
percentage of pottential GDP
2
actual
We must exercise care
when interpreting
the reported deficit figures
figures.
1
0
cyclicallyadjusted
dj t d
-1
-2
-3
-4
-5
-6
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
Is the govt debt really a problem?
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The traditional view
 Short run: Y, u
 Long run:
 Y and u back at their natural rates
 closed economy: r,
r I
 open economy: , NX
Consider a tax cut with corresponding increase
in the government debt.
Two viewpoints:
1 Traditional
1.
T diti
l view
i
2. Ricardian view
(or higher trade deficit)
 Very long run:
 slower growth until economy reaches new
steady state with lower income per capita
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Government Debt and Budget Deficits
The Ricardian view
The logic of Ricardian Equivalence
 due to David Ricardo (1820),
 Consumers are forward-looking,
more recently advanced by Robert Barro
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know that a debt-financed tax cut today
implies an increase in future taxes
that is equal – in present value – to the tax cut.
 According to Ricardian equivalence,
a debt-financed tax cut has no effect on
consumption,
ti
national
ti
l saving,
i
th
the reall iinterest
t
t
rate, investment, net exports, or real GDP,
even in the short run.
 The
Th tax
t cutt does
d
nott make
k consumers better
b tt off,
ff
so they do not increase consumption spending.
Instead, they save the full tax cut in order to repay
the future tax liability.
 Result: Private saving rises by the amount public
saving falls, leaving national saving unchanged.
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Evidence against Ricardian Equivalence?
Problems with Ricardian Equivalence
 Myopia: Not all consumers think so far ahead,
Early 1980s:
Reagan tax cuts increased deficit.
National saving fell, real interest rate rose,
exchange rate appreciated, and NX fell.
some see the tax cut as a windfall.
 Borrowing constraints: Some consumers
cannot borrow enough to achieve their optimal
consumption so they spend a tax cut
consumption,
cut.
1992:
Income tax withholding reduced to stimulate economy.
 Future generations: If consumers expect that
the burden of repaying a tax cut will fall on future
generations, then a tax cut now makes them feel
better off, so they increase spending.
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Government Debt and Budget Deficits
 This delayed taxes but didn’t make consumers
better off.
 Almost half of consumers increased consumption.
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OTHER PERSPECTIVES: Balanced budgets
vs. optimal fiscal policy
Evidence against Ricardian Equivalence?
 Some politicians have proposed amending the
 Proponents of R.E. argue that the Reagan tax cuts
U.S. Constitution to require balanced federal
govt budget every year.
did not provide a fair test of R.E.
 Consumers may have expected the debt to be
 Many economists reject this proposal, arguing
repaid with future spending cuts instead of
f t
future
tax
t hikes.
hik
 Private saving may have fallen for reasons
other than the tax cut, such as optimism about
the economy.
that deficit should be used to:
 stabilize output & employment
 smooth taxes in the face of fluctuating income
 redistribute income across generations when
appropriate
 Because the data is subject to different
interpretations, both views of govt debt survive.
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Debt and politics
Fiscal effects on monetary policy
 Govt deficits may be financed by printing money
 A high govt debt may be an incentive for
“Fiscal policy is not made by angels…”
– N. Gregory Mankiw, p.487
 Some do not trust policymakers with deficit spending.
policymakers to create inflation (to reduce real
value of debt at expense of bond holders)
They argue that:
 policymakers do not worry about true costs of their
spending, since burden falls on future taxpayers
 since future taxpayers cannot participate in the
decision process, their interests may not be taken
into account
Fortunately:
 little evidence that the link between fiscal and
monetary policy is important
 most governments know the folly of creating
inflation
 most central banks have (at least some) political
independence from fiscal policymakers
Government Debt and Budget Deficits
Government Debt and Budget Deficits
OTHER PERSPECTIVES:
OTHER PERSPECTIVES:
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 This is another reason for the proposals for a balanced
budget amendment (discussed above).
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OTHER PERSPECTIVES:
CASE STUDY:
International dimensions
Inflation-indexed Treasury bonds
 Govt budget deficits can lead to trade deficits,
 Starting in 1997, the U.S. Treasury issued bonds
which must be financed by borrowing from
abroad.
with returns indexed to the CPI.
 Benefits:
 Removes inflation risk, the risk that inflation
 Large govt debt may increase the risk of capital
flight, as foreign investors may perceive a
greater risk of default.
– and hence real interest rate – will turn out
different than expected.
 May encourage private sector to issue
inflation-adjusted bonds.
 Provides a way to infer the expected rate of
inflation…
 Large debt may reduce a country’s political clout
in international affairs.
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CASE STUDY:
Inflation-indexed Treasury bonds
percent (an
nnual rate)
6
31
Chapter Summary
moderate compared to other countries
2. Standard figures on the deficit are imperfect
4
measures of fiscal policy because they:
implied expected inflation rate
 are nott corrected
t d for
f inflation
i fl ti
 do not account for changes in govt assets
2
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Government Debt and Budget Deficits
1. Relative to GDP, the U.S. government’s debt is
rate on non-indexed bond
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rate on indexed bond
 omit some liabilities (e.g., future pension
payments to current workers)
 do not account for effects of business cycles
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2003- 2003- 2004- 2004- 2004- 2005- 2005- 2006- 2006- 200701-03 07-04 01-02 07-02 12-31 07-01 12-30 06-30 12-29 06-29
Chapter Summary
3. In the traditional view, a debt-financed tax cut
increases consumption and reduces national
saving. In a closed economy, this leads to higher
interest rates, lower investment, and a lower longrun standard of living. In an open economy, it
causes an exchange rate appreciation, a fall in net
exports (or increase in the trade deficit).
4. The Ricardian view holds that debt-financed tax
cuts do not affect consumption or national saving,
and therefore do not affect interest rates,
investment, or net exports.
Chapter Summary
5. Most economists oppose a strict balanced budget
rule, as it would hinder the use of fiscal policy to
stabilize output, smooth taxes, or redistribute the
tax burden across generations.
6 Government debt can have other effects:
6.
 may lead to inflation
 politicians can shift burden of taxes from current
to future generations
 may reduce country’s political clout in
international affairs or scare foreign investors into
pulling their capital out of the country
6