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Chapter 13: Government Borrowing
Chapter 13
McGraw-Hill/Irwin
Government Borrowing
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved
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Chapter 13: Government Borrowing
Introduction
Deficit versus debt
The burden of debt
U.S. deficits, debt, and interest during the
past half century
Inflation, debt, and deficits
The long-term budget outlook for the U.S.
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Chapter 13: Government Borrowing
Deficit versus Debt
Deficit
• Spending minus taxes in a given year
• A flow that occurs during a period of time –
one year
Debt
• The cumulative result of the deficits in prior years
• A stock that is measured at a point in time
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Chapter 13: Government Borrowing
Common Sense Concern about
Excessive Borrowing
… excessive borrowing today means
heavy payments to creditors tomorrow.
• This does not mean that all borrowing should be avoided
• Individuals, firms, and government are justified to borrow
for long-lived productive assets
If the government defaults on loans, then…
• Creditors may become wary
• There may be increased taxes or a cut in spending
• Inflation may occur if the government prints money
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Chapter 13: Government Borrowing
The Burden of the Debt
The burden of family borrowing
• Children are not legally responsible for their
parents’ borrowing
• In some cases, parents’ borrowing imposes a
burden on children
The burden of government borrowing
• Government borrowing shifts the burden
of today’s government spending from
today’s taxpayers to tomorrow’s taxpayers
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Chapter 13: Government Borrowing
Capital Expenditures
Is it fair to shift the burden of today’s
government spending? It depends.
Borrowing is inappropriate when government
spending doesn’t benefit tomorrow’s taxpayers.
• Current expenditures
Borrowing is appropriate when government
spending does benefit tomorrow’s taxpayers.
• Capital expenditures
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Chapter 13: Government Borrowing
Government Borrowing, Interest Rates,
and the Crowding Out of Investment
Figure 13.1
• The government
increases borrowing
to finance spending
Interest Rate (r)
S
•
r1
r0
D’
r increases
• Government
borrowing crowds out
private investment
D
F0
F1
Loanable Funds (F)
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Chapter 13: Government Borrowing
Disciplining Politicians
with a Balanced Budget Rule
Spending must be entirely financed by tax revenue.
• Politicians and citizens naturally demand
excessive spending
• A balanced budget leads to optimal spending
An always balanced budget rule
• The prohibition on borrowing and printing money
• The problem is that this rule may make a recession
worse
• FEBAR compared to NUBAR
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Chapter 13: Government Borrowing
A Normal-Unemployment Balanced Budget Rule
NUBAR
A planned balanced budget for next year is based on an
estimate if next year’s unemployment rate is normal.
• Would avoid worsening a recession
• Would provide discipline
Questions
• How would it be implemented?
• How would it be enforced?
• What about a recession or a war?
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Chapter 13: Government Borrowing
Fiscal Imbalance
=(
The present value of
future promised benefits
) (
The present value of
future assigned taxes
)
Suppose $110,000 is promised next year and $100,000
of taxes is raised this year. Is the $100,000 enough?
• It depends on the interest rate.
Examples of
long-term
fiscal imbalance
• Medicare
• Social Security
• Federal debt
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Chapter 13: Government Borrowing
Generational Accounting
…focuses on how each generation fares with respect
to government taxing and spending
=(
The present value of
benefits it receives
) (
The present value
of taxes it pays
)
• Some generations get a better or worse deal from
government taxing and spending
Examples
• Social Security
• First public schools
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Chapter 13: Government Borrowing
U.S. Treasury Debt Held by the Public and
by U.S. Government Agencies
Table 13.1
U.S. Treasury debt held by the public (U.S. net debt)
$5 trillion
U.S. Treasury debt held by the public – domestic
$2.8 trillion
U.S. Treasury debt held by the public – foreign
$2.2 trillion
U.S. Treasury debt held by the public – China, Japan, U.K.
$1.2 trillion
U.S. Treasury debt held by the public – All other countries
$1 trillion
U.S. Treasury debt held by U.S. government (including SS)
$4 trillion
Total U.S. Treasure debt (U.S. gross debt)
$9 trillion
U.S. GDP
$14 trillion
U.S. Treasury debt held by the public as a % of GDP
37%
Total U.S. Treasury debt as a % of GDP
63%
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Chapter 13: Government Borrowing
The Interest Burden of the U.S. Treasury
Table 13.2
1980
1993
2001
2007
U.S. net debt as a % of GDP
26%
49%
33%
37%
Interest rate on U.S. Treasury bonds
7.3%
6.1%
6%
4.6%
Net interest as a % of GDP
1.9%
3%
2%
1.7%
Revenue as a % of GDP
19%
17.5%
19.8%
18.8%
Net interest as a % of revenue
10%
17%
10%
9%
% of revenue available to finance programs
90%
83%
90%
91%
Source: CBO, The Budget and Economic Outlook: Fiscal Years 2008 to 2018 (Jan. 2008), Table F-2 and F-6
Consequences for
the interest burden
• Net debt as a percent of GDP
• Bond interest rate
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Chapter 13: Government Borrowing
The Deficit, Debt, and Interest as
a Percent of GDP
Table 13.3
g = 5%
f = 5%
r = 5%
Year
Debt
GDP
b
Deficit
Interest
i
0
$5,000
$10,000
50%
$500
$250
2.5%
1
$5,500
$10,500
52.4%
$525
$275
2.62%
2
$6,025
$11,025
54.6%
$551.25
$301.25
2.73%
Long Run
100%
5%
b* = f/g
i* = rb* = r(f/g)
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Chapter 13: Government Borrowing
Inflation, Debt, and Deficits
Real surplus
= (Taxes) – (Spending) + (the reduction in the real value
of the debt due to inflation)
= (Nominal surplus) + (the reduction in the real value
of the debt due to inflation)
Real deficit
= (Spending) – (Taxes) – (the reduction in the real value
of the debt due to inflation)
= (Nominal Deficit) – (the reduction in the real value
of the debt due to inflation)
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Chapter 13: Government Borrowing
Generating Inflation
Combined fiscal-monetary stimulates the economy
• Which raises aggregate demand for goods
and services above supply
• Which causes prices to rise – inflation
Separation of powers
• Congress and the president have the power to
borrow money from the public
• The Federal Reserve has the power to inject
money into the economy
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Chapter 13: Government Borrowing
Generating Inflation
Do deficits directly cause inflation?
Deficits and inflation
• Deficits can cause inflation
• Deficits do not have to generate inflation
• Excess demand raises inflation
• Deficient demand reduces inflation
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Chapter 13: Government Borrowing
The Long-Term Budget Outlook for the U.S.
• Average federal spending ~ 20% of GDP
• Average federal revenue ~ 18% of GDP
Figure 1.11
% of GDP
24%
23%
22%
Federal
Spending
21%
20%
19%
18%
Federal
Taxes
17%
16%
1965
1970
1975
1980
1985
1990
1995
2000
2005 Year
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Chapter 13: Government Borrowing
The Long-Term Budget Outlook for the U.S.
• Average federal deficit ~ 2% of GDP
Figure 1.12
% of GDP
50%
45%
40%
Federal
Debt
35%
30%
25%
1965
1970
1975
1980
1985
1990
1995
2000
2005 Year
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Chapter 13: Government Borrowing
Summary
Deficit versus debt
The burden of debt
U.S. deficits, debt, and interest during the
past half century
Inflation, debt, and deficits
The long-term budget outlook for the U.S.
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