11 22 2011 Budget Deficits and Debt Chapter 16 11 15 11 Definition Budget Deficit BD for a given year BD Government outlays Tax revenues Keynesian Model BD G tR tY National Debt total stock of government liabilities For US fiscal 2011 outlays 3 6 trillion 24 of GDP tax revenues 2 3 trillion 15 BD 1 3 trillion 9 At end of 2011 Net ND national debt owed to public 10 2 trillion 6 8 of GDP payments TR BD for a given year ND for that year note interest payments on ND are counted as a part of transfer contribute to budget deficit Principal repayments on ND are not counted as G or TR Example ND 10 T at end of Fiscal year 2011 suppose in FY 2012 government outlays 3T Revenues 3T BD 0 balanced budget Government would roll over expiring ND issues ND end of FY12 10T If BD 0 the government rolls over expiring part of existing national debt but issues no new net ND ND stays the same same as if in debt with one credit card open a new credit card to repay debt roll over issue new debt to pay off principal on expiring ND Same example ND 10T at end of FY12 Government outlays 3T Revenues 2 5T BD in FY12 3T 2 5T 5T or 500 B ND at end of FY12 10T 500 B 10 5T If government runs a deficit the ND will rise in this case Government rolls over all expiring ND and it issues 500 B of new net ND to finance this years BD One more case same example Revenues in FY12 3 3T Outlays 3T surplus BD for FY12 3T 3 3T 3T 300B ND at end of FY12 10T 300B 9 7 T When government runs a surplus levels of ND falls in this case government uses surplus to pay off redeem 300B of expiring ND without rolling it over How have ND BD behaved over time in US PG 1 of handout Top figure BD 1981 2010 Middle figure outlays GDP revenues GDP Difference BD GDP Bottom figure shows debt ratio ND Nominal GDP since 1918 1 BD and debt ratio are countercyclical rise during recessions fall during Top figure BD rose during recessions of early 80s early 90s now Bottom figure debt ratio spikes during recession 1974 75 early 80s Notice booms now Why are BD s ND countercyclical Two reasons A built in tendency for BD s to rise during recessions even if the government is not pursuing Keynesian policies WHY Holding governments Fiscal Policies G TR t fixed tax revenues in Keynesian model will automatically fall in recessions do to decrease in Y most revenues are proportional to economic activity and activity falls in recession e g income tax Example t 25 MPC 8 multiplier 2 5 Suppose stock market crash A decreases by 100 Holding G TR and t fixed what happens to BD BD G TR tY holding t fixed BD G TR t Y Here G TR t 0 Y 2 5 100 250 BD 0 0 25 250 62 6 In general holding fiscal policy fixed deficits will tend to rise during recessions because a decrease in Y will lead to a decrease in tax revenue in Keynesian model and real world Also in real world not Keynesian model TR tend to rise automatically in recessions BD are not entirely under control of government given fiscal policy choices G TR t BD will tend to rise any time a bad shock to economy occurs B When governments pursue Keynesian style fiscal policies to counteract recession g increase TR increase t decrease this will further increase BD beyond automatic increase due to recession note Keynesian expansionary policies will increase BD but less than 1 for 1 due to offsetting effects on Y and thus tax revenue Use above example suppose G increases by 100 what s the impact on BD in this case t and TR are fixed BD G t Y G 100 t 25 Y 2 5 x 100 250 BD 100 25 250 100 62 5 37 5 2 Aside from recessions and Keynesian response to recessions BD and ND also depend on long term non Keynesian fiscal policy choices A wars increase BD and debt ratio G increases B tax cuts will increase BD and increase the debt ratio 1981 2011 C tax increases spending cuts will decrease BD debt ratio 1990 Notice 1993 BD decreases during 1990s surpluses 1998 2001 3 Debt ratio ND NGDP can fall over time for 2 reasons A run budget surpluses e g 1998 2001 ND will fall B even if BD 0 or if BD 0 but small debt ratio can fall due to growth in NGDP due to growth in RGDP or 1947 73 low BD s ND growing slowly don t have to run growth surpluses to decrease debt ratio 1947 73 NGDP grew quickly and debt ratio fell november 11 What are consequences of chronic high deficits debt 1 high deficits high debt ration can lead to DEFAULT on ND could US pay entire ND today NO o ND NGDP 68 o Tax rev 15 of GDP in FY2011 reality US doesn t ever have to repay entire principle of ND o unlike person countries don t die as long as investors confident that the US can repay the interest on ND debt service every year they will keep rolling over principle on ND AD infinitum solvency of a country depends on whether country can reliably meet its debt service obligations pay interest on ND ex 2011 US debt service 215 B 1 5 of GDP US solvency is NOT currently under threat this summer debt ceiling tax receipts 15 of GDP in general best indicators of solvency is debt service debt service i nominal i on ND x ND national debt debt service NGDP i x debt ratio ND NGDP a countries potential solvency depends on two factors 1 Debt ration ND NGDP a higher debt ratio makes default insolvency more likely bigger monthly i by increasing debt service payments 2 interest rate i higher i means default more likely to increase on ND debt service payments currently in US debt ratio 68 of GDP high but not as high as late 40 s early 50s i on ND in FY2011 interest payments 215 B ND 10T so for the US today average i on ND 2 15 one of the lowest of the world Italy today debt ratio 120 of GDP i on newly issues ND over 7 the debt ratio and interest rate on ND are interrelated 1 high debt scares investors who then demand high i to compensate for risk 2 when i on ND is high government has to spend more on debt service debt service is part of governments outlays higher debt service increases current BD more ND high debt ration in future death spiral debt ratio too high investors fear default i increases on ND debt service increases outlays increase budget deficit increases ND increases debt ration too high o self fulfilling prophecy could death …
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