Download Views of American leaders on the national debt

Views of American leaders on the national debt
“A national debt, if it is not excessive, will be to us a national blessing.”
[Alexander Hamilton, 1781]
“It’s a public debt… we owe it to ourselves… therefore, we never have to pay it
back.” [F. D. Roosevelt]
“There are myths also about our public debt. Borrowing can lead to overextension and collapse – but it can also lead to expansion and strength.
There is no single, simple slogan in this field that we can trust.”
[John F. Kennedy, Yale Commencement Address, 1962]
“It is critical that we rein in the budget deficits we’ve been accumulating for far
too long – deficits that won’t just burden our children and grandchildren,
but could damage our markets, drive up our interest rates, and jeopardize
our recovery right now.” [B. Obama, 2010]
1
Five Genuine Concerns about Government Debt
1. Impact on growth of potential output
- Higher deficit and debt leads to lower saving and capital stock
- Leads to lower potential output (we will review the savings experiment)
2. Efficiency impacts of higher debt:
- Higher debt means higher interest payments
- These require higher taxes, and this has a “dead-weight loss”
3. In open economy, some of debt will be held abroad
- To extent that have net foreign borrowing (trade deficit), this requires net
exports to pay.
- If debt is in foreign currency, can lead to financial crisis, higher interest
rates, higher deficits, and a death spiral of confidence, and eventual default
4. Higher debt forces higher taxes or crowds out other critical spending
2
The overall federal budget
26
Spending/GDP
Deficit
24
22
20
18
Revenues/GDP
16
14
1960
1970
1980
1990
2000
2010
3
Current projections of debt/GDP
“Extended Alternative” = continuation of certain policies (war, Bush era tax cuts, Medicare, etc.).
“Extended Baseline” = cliff
Long-term projection of debt/GDP
CBO, The Long-Term Budget Outlook, June 2010
5
What are the sources of the spending growth?
Projected federal spending as % of GDP
14
12
10
8
6
4
Social Security
Health
Everything else
2
0
2010
2015
2020
2025
2030
2035
2040
CBO, The Long-Term Budget Outlook, June 2010/
6
Debt bathtub
Spending
Debt (end of year) = Debt (beginning) + deficit
Debt (beginning of year)
Revenues
7
Debt algebra
Basic identity:
Debt (end of t) = Debt (beginning of t) + Deficit (t)
Stable system when debt-GDP ratio is constant.
Define debt-GDP ratio = β
Primary surplus = PS = taxes – noninterest spending.
Given U.S. parameters, stable β when PS = 0.
Algebra of stable debt - GDP ratio.
Assume g = nominal GDP growth. Then, equation for change in debt is:
D/t  iD  PS
Then debt-GDP (  = D/Y) ratio is constant when
  /t  /   0   D/t  / D  g   [ iD  PS  / D]  g  ( i  g )  PS / D
Historically for the U.S., i  g, so a stable financial situation implies that
the primary deficit must be zero PS  0).
Primary surplus ratio
Recession
and
stimulus
package
6%
Clinton-era
surpluses
4%
2%
0%
1981
1986
1991
1996
2001
2006
2011
2016
-2%
-4%
Cliff fiscal policy
-6%
Extended baseline (current
law)
-8%
Actual
-10%
CBO
Forecast
2021
Case 1. Closed classical economy
• Fundamental difference between spending on I and spending on C:
- Borrowing for spending on productive I does not lower long-run C
- Growth lowered from borrowing for government or private C
• Two problems from domestic debt (or closed economy debt)
- Internal debt requires taxation to service and leads to inefficiency
- Debt crowds out capital and reduces the growth/level of potential output
10
The marginal dead weight loss of debt/taxes
Empirical estimates: 20 – 40
cents of DWL per $ of taxes
from higher tax rates
= incremental DWL of higher taxes
P(1+τ2)
~ increase revenues
P(1+τ1)
DWL
P
X2
X1
X0
Taxes and debt for a purely internal debt
Assume that we “owe the debt to ourselves”
- Many identical people
- All get benefits and pay taxes to service debt
- Suppose that we have program which provides $1 in PV of C;
and finances it by $1 of debt.
Classical case:
- Suppose no change in path of output.
- Higher interest payments with present value of $1.
- Taxes cause efficiency losses with a dead-weight loss (DWL).
- If marginal DWL on taxes is 30%, then have cost of $0.30.
- Net value of government program is minus $0.30.
12
Debt in neoclassical growth model
National investment = national saving
= private saving + government saving
NS = PS + GS
If PS unchanged, then higher deficit leads to lower saving and
investment.
Then follow through standard Solow neoclassical growth model,
with lower s.
13
Impact of Deficits on Economy
y = f(k)
y*
y**
i = s1f(k)
i = s2f(k)
(I/Y)*
(n+δ)k
k
k**
k*
14
ln K, ln GD
ln K
ln K’
ln GD’
ln GD
time
15
ln Y, ln C
ln Y
ln Y’
ln (C+G)
ln (C+G)’
Note that govt spending first
raises (C+G), but then lowers (C+G)’
time
16
Case 2. Impact of government debt in an open
economy (assuming borrowing in own currency)
• In open economy:
K + NFA = Wealth = Private wealth – Government Debt
W/L = v = (K + NFA)/L = k +nfa, where nfa=NFA/L
• For small open economy, the marginal investment is abroad!
– With r = rw, no change in domestic capital stock!
– Therefore, no effect on GDP, but has effect on income from abroad
– Will show up in national income (NNP) not in GDP!
(Most macro models get this wrong.)
• Large open economy like US:
– Somewhere in between small open and closed.
– I.e., some decrease in domestic I and some in decrease net foreign
assets
• But results on changes in W and C are same in open as closed
economy.
17
Solow model for open economy with net foreign borrowing
y=NNP/L;
v = per
capita wealth
v= k + nfa;
(n+δ)k
Show how:
↓s → ↓v →
↓nfa but no
change k →
↓y
nfa*
k, v
v*
k*
18
The fiscal cliff
Everything goes poof on December 31, 2012.
Tax cuts expire, doctors don’t get paid, unemployed lose
insurance, military and government programs slashed, rich get
big tax increase.
The actual details…
19
Fiscal Cliff
[billions of dollars at annual rate]
Bush era tax cuts
High income and estate
"Middle class"
Payroll tax
Other expiring provisions
Taxes included in the Affordable Care Act
Other misc taxes
TOTAL, Revenues
Calendar year
2013
295
66
229
127
87
24
105
637
Changes in Specified Spending Policies
Budget Control Act
Unemployment insurance
Medicare "doc fix"
Other
87
35
15
35
TOTAL, Expenditures
171
Total Change in Deficit
As % of GDP
808
4.9%
Source: CBO, May 2012
20
Fiscal Cliff
[billions of dollars at annual rate]
Bush era tax cuts
High income and estate
"Middle class"
Payroll tax
Other expiring provisions
Taxes included in the Affordable Care Act
Other misc taxes
TOTAL, Revenues
Calendar year
2013
295
66
229
127
87
24
105
= contentious.
637
Changes in Specified Spending Policies
Budget Control Act
Unemployment insurance
Medicare "doc fix"
Other
87
35
15
35
TOTAL, Expenditures
171
Total Change in Deficit
As % of GDP
808
4.9%
Source: CBO, May 2012
21
Game of chicken and the cliff
R’s concede
R’s hang tough
D’s concede
• No recession.
• Everyone one
looks good.
• Politically
neutral.
• No recession.
• Obama loses face
early in second term.
• Repubs get
overconfident.
D’s hang tough
• No recession.
• Repubs lose
face.
• Dems get
overconfident.
• Deep recession.
• Everyone looks
equally bad
politically.
***
*** Nash equilibrium if prisoners’ dilemma zero-sum structure.