Download Deficit Spending and the Public Debt

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Deficit Spending and
the Public Debt
Learning Objectives
After you have studied this chapter, you should be able to
1.
define government budget deficits and surpluses, a balanced budget, the public debt, the gross
public debt, the net public debt, entitlements, and noncontrollable expenditures;
2.
explain why government budget deficits and surpluses are flows and why measures of the public
debt are stocks;
3.
distinguish between the gross public debt and the net public debt;
4.
explain in what ways that government budget deficits and an accumulating public debt might be
burdensome to society;
5.
recognize why there can be a relationship between government budget deficits and trade deficits;
6.
discuss the macroeconomic effects of government budget deficits; and
7.
enumerate ways in which the federal government could reduce its budget deficits.
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1.
Outline
The government’s accounts include both flows and stocks.
a. Government budget deficits or surpluses are flows during a period of time, such as a year.
i. A government budget deficit occurs whenever government spending exceeds
government revenues during a given period of time.
ii. A government budget surplus occurs whenever government revenues exceed
government spending during a given period of time.
iii. The federal government experiences a balanced budget whenever government spending
is exactly equal to the government’s total revenues from taxes and other sources during
a given period.
b. The public debt is a stock measured at a given point in time.
i. The public debt is the total value of all outstanding federal government securities.
ii. The public debt is the accumulation of past government budget deficits.
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2.
There are two ways to measure the public debt.
a. The gross public debt consists of all federal government debt, irrespective of who owns it.
b. The net public debt is equal to the gross public debt minus all government interagency
borrowings.
3.
There are two ways that government budget deficits and an accumulating public debt might be
burdensome to society.
a. A higher public debt can burden future generations if the government purchases that federal
deficits are used to finance do not lead to increases in real GDP and if the federal deficits
crowd out investment spending and thereby lead to a smaller future capital stock.
b. To the extent that the public debt is purchased by residents of other nations, a higher public
debt can be burdensome if its accumulation leads to less domestic growth, so that future
generations that repay the debt will transfer a larger share of their incomes abroad when
they incur higher taxes to repay the debt.
4.
A trade deficit, a situation in which the value of imports of goods and services exceeds the value
of exports, will often accompany a government budget deficit.
a. If domestic consumption and investment remain unchanged percentages of GDP when
government spending increases or taxes decrease, then funds to finance the government
budget deficit must come from abroad.
b. Foreign households, businesses, and governments will have an incentive to purchase
domestic government debt if domestic interest rates rise, but if they buy more domestic
bonds they will purchase fewer domestic exports of goods and services. Domestic exports
decline, and the domestic trade deficit rises.
5.
The macroeconomic consequences of government budget deficits depend on whether we
consider their short-run or long-run effects.
a.
The short-run effects of government budget deficits depend on the economy’s situation
during the short-run period in which the deficits occur.
i. If the economy experiences a recessionary gap at the time that the government operates
with a deficit, then the increase in aggregate demand resulting from higher government
spending or lower taxes pushes real GDP toward its full-employment level.
ii. If the economy is already at full-employment real GDP, then an increase in aggregate
demand resulting from a deficit-inducing rise in government spending or fall in taxes
results in an inflationary gap.
b. In the long run, after all adjustments have occurred, a higher government budget deficit has
no effect on equilibrium real GDP, so the only effect of a higher deficit is the redistribution
of a larger share of real GDP to government-produced goods and services.
6.
There are two basic ways that the federal government could attempt to reduce budget deficits.
a. With government spending unchanged, tax increases could reduce federal budget deficits.
b. With taxes unchanged, reduced government spending could reduce federal budget deficits,
but spending on entitlement programs such as Social Security complicate this approach
because these forms of spending are noncontrollable expenditures.
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Chapter 14 Deficit Spending and the Public Debt
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Key Terms
Balanced budget
Gross public debt
Entitlements
Net public debt
Government budget deficit
Noncontrollable expenditures
Government budget surplus
Public debt
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187
Key Concepts
Burdens of the public debt
Stock
Flow
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Completion Questions
Fill in the blank, or circle the correct term.
1. The government budget deficit is measured (over time, at a point in time) and consequently is a
(flow, stock).
2. The public debt is measured (over time, at a point in time) and consequently is a (flow, stock).
3. The public debt arises from (an accumulation, a subtraction) of past (deficits, balanced budgets).
4. An excess of government spending over total government revenues is a(n) ________________.
An excess of total government revenues over government spending is a(n) _________________.
A situation in which government spending exactly equals total government revenues is
a(n) ________________.
5. The ___________ public debt includes all federal government debt, irrespective of who owns it,
and the ___________ public debt excludes all government interagency borrowing.
6. If government budget deficits result in crowding out of investment and thereby reduce growth
in the nation’s (consumption, capital stock), then the resulting debt can be a burden for
(current, future) generations.
7. A higher public debt can be a burden if it results in more purchases of government bonds by
(domestic, foreign) households, businesses, and governments, thereby resulting in a burdensome
transfer from (this nation to foreign countries, foreign nations to this country).
8. In an open economy, a higher government budget deficit is often associated with a higher
________________ deficit.
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9. If the economy is initially in a recessionary-gap situation and the government’s budget is
balanced, then cutting taxes while keeping government spending unchanged will result in a
government budget (deficit, surplus) and, in the short run, cause equilibrium real GDP to
(remain unchanged, rise toward its full-employment level).
10. If all macroeconomic adjustments have occurred, real GDP is initially at its full-employment
level, and the government’s budget is balanced, then increasing government spending while
keeping taxes unchanged will result in a government budget (deficit, surplus) and, in the long
run, cause equilibrium real GDP to (remain unchanged, rise above its full-employment level).
11. Spending on entitlements such as Social Security, Medicare, and other government-provided
health care are (controllable, noncontrollable) expenditures that currently account for
(more than, less than) half of all federal government spending.
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True-False Questions
Circle the T if the statement is true, the F if it is false. Explain to yourself why a statement is false.
T F
1. An excess of government spending over total government tax revenues is measured as a
stock at a point in time.
T F
2. If the federal government operates with a surplus during the current year that exceeds
any interest it owes on the outstanding public debt, then the public debt will decline
during that year.
T F
3. Since 1940, the federal government has experienced budget surpluses in more years than
it has experienced budget deficits.
T F
4. The most recent period in which the federal government officially operated with annual
budget surpluses was from 1998 to 2001.
T F
5. The net public debt equals the gross public debt minus government interagency
borrowing.
T F
6. Government budget deficits and resulting increases in the public debt necessarily impose
burdens on future generations.
T F
7. If foreign residents respond to higher U.S. interest rates by purchasing more U.S.
government bonds, then, if all other things are equal, they will purchase fewer U.S.
exports, thereby contributing to a higher U.S. trade deficit.
T F
8. If real GDP is initially at its full-employment level and the federal government
experiences an increase in its budget deficit, then the long-run effect of the higher
budget deficit will be an increase in real GDP.
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Chapter 14 Deficit Spending and the Public Debt
T F
189
9. If real GDP is initially below its full-employment level and the federal government
experiences an increase in its budget deficit, then the short-run effect of the higher
budget deficit will be an increase in real GDP.
T F 10. In the long run, higher government deficits leave equilibrium real GDP unchanged and
simply redistribute a larger share of real GDP to government-provided goods and
services.
T F 11. Spending on entitlements such as Social Security, Medicare, and other health programs
currently accounts for almost 60 percent of total U.S. federal government expenditures.
T F 12. Government spending on Social Security, Medicare, and other health programs are
examples of noncontrollable expenditures that change automatically without action by
Congress.
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Multiple Choice Questions
Circle the letter that corresponds to the best answer.
1. If federal government spending and total government revenues from taxes and other sources
during a given period of time equal the same dollar amounts, then the government experiences
a.
b.
c.
d.
a budget deficit.
a budget surplus.
a balanced budget.
none of the above.
2. An excess of government spending over total government revenues from taxes and other sources
during a given period of time is
a.
b.
c.
d.
a flow.
a stock.
the net public debt.
the gross public debt.
3. The total value of all outstanding federal government securities at a point in time is
a.
b.
c.
d.
the public debt.
a balanced budget.
a government budget deficit.
a government budget surplus.
4. During the period from 1998 to 2001, the U.S. federal government officially operated with
a.
b.
c.
d.
annual balanced budgets.
annual budget surpluses.
annual budget deficits.
no public debt.
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5. Since 2001, the federal government has experienced
a.
b.
c.
d.
a stock of government spending in excess of a stock of government revenues.
a stock of government revenues in excess of a stock of government spending.
annual balanced budgets.
a growing public debt.
6. Which one of the following should be included in the gross public debt?
a. U.S. Treasury securities purchased by an office of the federal government’s Department of
Housing and Urban Development
b. U.S. Treasury securities purchased by a federal government agency called the Government
National Mortgage Association
c. U.S. Treasury securities purchased by the parents of a college student
d. All of the above
7. Which one of the following should not be included in the net public debt?
a. U.S. Treasury securities held by a private bank
b. U.S. Treasury securities held by a small business based in Houston, Texas
c. U.S. Treasury securities held by the Internal Revenue Service, which is part of the U.S.
Treasury department
d. All of the above
8. How can higher interest rates induced by increased U.S. government budget deficits contribute
to the potential for these deficits to be burdensome to future generations?
a.
The higher interest rates discourage foreign households, businesses, and governments from
purchasing U.S. government securities.
b. The higher interest rates discourage U.S. households, businesses, and governments from
purchasing U.S. government securities.
c. The higher interest rates crowd out consumption spending, so that the net effects of higher
deficit spending are a decrease in total planned expenditures and a reduction in real GDP.
d. The higher interest rates crowd out investment spending, and as a result, the nation’s capital
stock and real GDP will be lower for future generations than it would have been otherwise.
9. Which one of the following can correctly help to explain why higher U.S. federal budget deficits
that boost the U.S. public debt might prove burdensome to future U.S. taxpayers?
a.
b.
c.
d.
Foreign holders of the U.S. public debt will receive transfers from future U.S. taxpayers.
Future U.S. taxpayers will receive transfers from foreign holders of the U.S. public debt.
A portion of deficit spending by the federal government is on capital goods.
None of the above.
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10. Which of the following can correctly help to explain why U.S. government budget deficits can
be directly related to U.S. trade deficits?
a. Higher U.S. interest rates induced by government budget deficits discourage foreign
residents from purchasing U.S. government securities, and as a consequence, foreign
residents purchase more U.S. exports.
b. Higher U.S. interest rates induced by government budget deficits encourage foreign
residents to purchase U.S. government securities, and as a consequence, foreign residents
purchase fewer U.S. exports.
c. Higher U.S. import spending increases the portion of domestic goods and services available
for the government to purchase, which contributes to the occurrence of government budget
deficits.
d. Higher U.S. import spending reduces the portion of income available for the government to
tax, which contributes to the occurrence of government budget deficits.
11. Suppose that the government initially had a balanced budget but then experiences a budget
deficit. If the results are a rise in the equilibrium price level but no change in equilibrium real
GDP, then the economy was initially in
a.
b.
c.
d.
a long-run equilibrium situation and has remained in this situation.
a recessionary-gap situation and has now attained a long-run equilibrium.
an inflationary-gap situation and has now attained a long-run equilibrium.
a long-run equilibrium situation but now operates with a recessionary gap.
12. Suppose that the government initially had a balanced budget but then experiences a budget
deficit. If the results are an increase in the equilibrium price level and a rise in equilibrium real
GDP to its full-employment level, then the economy was initially in
a.
b.
c.
d.
a long-run equilibrium situation and has remained in this situation.
a recessionary-gap situation and has now attained a long-run equilibrium.
an inflationary-gap situation and has now attained a long-run equilibrium.
a long-run equilibrium situation but now operates with a recessionary gap.
13. Which of the following is true of the distribution of U.S. federal government expenditures?
a.
Since the early 1950s, government spending on Social Security, Medicare, and other health
programs as a percentage of total government spending has risen from less than 10 percent
to nearly 60 percent.
b. Since the early 1950s, government spending on national defense as a percentage of total
government spending has risen from about 20 percent to almost 70 percent.
c. Since the early 1950s, noncontrollable expenditures have decreased as a percentage of total
government spending.
d. There has been almost no change in the distribution of government spending among
national defense and entitlements.
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Miller • Economics Today, Seventeenth Edition
Matching
Choose an item in Column (2) that best matches an item in Column (1).
(1)
(a)
government budget deficit
(b)
net public debt
(c)
(2)
(h)
excess of government spending over
government revenues
balanced budget
(i)
noncontrollable expenditures
(d)
entitlement
(j)
government budget surplus
(e)
Medicare and other government health
spending
(k)
equality of spending and revenues
(l)
Social Security program
(f)
government revenues in excess of spending
(m) public debt
(g)
total value of all outstanding federal
government securities
(n)
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Working with Graphs
1.
excludes government interagency
borrowing
Consider the diagram below when answering the following questions, and assume that the
government’s budget is balanced at the initial equilibrium point, which is Point E.
a. What situation—a recessionary gap, an inflationary gap, or a long-run equilibrium—exists at
Point E?
b. If the government’s tax revenues remain constant, but the government’s expenditures
increase, what will take place on the diagram?
c. What will happen to equilibrium real GDP in the short run? Will it rise, fall, or remain
unchanged?
d. What will happen to the equilibrium price level in the short run? Will it rise, fall, or remain
unchanged?
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Chapter 14 Deficit Spending and the Public Debt
2.
193
Consider the diagram below when answering the following questions, and assume that the
government’s budget is balanced at the initial equilibrium point, which is Point E.
a. What situation—a recessionary gap, an inflationary gap, or a long-run equilibrium—exists at
Point E?
b. If the government’s tax revenues remain constant but the government’s expenditures
increase, what will take place on the diagram?
c. What will happen to equilibrium real GDP in the short run? Will it rise, fall, or remain
unchanged?
d. What will happen to the equilibrium price level in the short run? Will it rise, fall, or remain
unchanged?
e. What will happen to equilibrium real GDP in the long run? Will it rise, fall, or remain
unchanged?
f. What will happen to the equilibrium price level in the long run? Will it rise, fall, or remain
unchanged?
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Answers
Completion Questions
1.
over time; flow
2.
at a point in time; stock
3.
an accumulation; deficits
4.
deficit; surplus; balanced budget
5.
gross; net
6.
capital stock; future
7.
8.
foreign; this nation to foreign
countries
trade
9.
deficit; rise toward its full
employment level
10.
deficit; remain unchanged
11.
noncontrollable; more than
True-False Questions
1.
F
2.
T
3.
F
4.
T
5.
T
6.
F
7.
T
8.
F
9.
T
10.
T
11.
T
12.
T
This is a situation of a government budget deficit, which is a flow.
In fact, government budget deficits have been much more common.
There may not be a burden if government spending yields sufficiently high economic
growth.
In the long run, after all adjustments, a higher budget deficit results in a redistribution of a
larger share of full-employment real GDP to government-provided goods and services.
Multiple Choice Questions
1. (c)
8. (d)
2. (a)
9. (a)
3. (a)
10. (b)
4. (b)
11. (a)
5. (d)
12. (b)
6. (d)
13. (a)
7. (c)
©2014 Pearson Education, Inc.
Chapter 14 Deficit Spending and the Public Debt
Matching
(a) and (h)
(e) and (i)
(b) and (n)
(f) and (j)
(c) and (k)
(g) and (m)
(d) and (l)
Working with Graphs
1.
a.
There is a recessionary gap at Point E.
b. Deficit spending will cause aggregate demand to increase, so the AD curve will shift
rightward.
c. Equilibrium real GDP will rise in the short run.
d. The equilibrium price level will rise in the short run.
2.
a.
There is a long-run equilibrium at Point E.
b. Deficit spending will cause aggregate demand to increase, so the AD curve will shift
rightward.
c. Equilibrium real GDP will rise in the short run.
d. The equilibrium price level will rise in the short run.
e. Equilibrium real GDP will end up at the level determined by LRAS in the long run.
f. The equilibrium price level will rise in the long run.
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Glossary
Balanced budget A situation in which the government’s spending is exactly equal to the total taxes and other revenues
it collects during a given period of time.
Entitlements Guaranteed benefits under a government program such as Social Security, Medicare, or Medicaid.
Government budget deficit An excess of government spending over government revenues during a given period of time.
Government budget surplus An excess of government revenues over government spending during a given period of time.
Gross public debt
All federal government debt, irrespective of who owns it.
Net public debt Gross public debt minus all government interagency borrowing.
Noncontrollable expenditures Government spending that changes automatically without action by Congress.
Public debt
The total value of all outstanding federal government securities.
©2014 Pearson Education, Inc.