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Chapter 23 Federal Deficits and

the National Debt• Key Concepts• Summary• Practice Quiz• Internet Exercises

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In this chapter, you will learn to solve these economic puzzles:

Can Uncle Sam go bankrupt?

How does the national debt of the United

States compare to other countries?

Are we passing the debt burden to our children?

Who owns the national debt?

Are there any advantages to a national debt?

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What is the purpose of this chapter?

To take a closer look at the actual budgetary process that creates and finances our national debt

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What are the four stages of the Budget Process?• Agency budget proposals• Presidential budget

submission• First budget resolution• Second budget resolution

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What is the Federal Fiscal Year?

October 1 through September 30

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What is theFederal Deficit?

How much money the government borrows in any given fiscal year

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What is theNational Debt?

The total amount owed by the federal government to owners of government securities

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How does the U.S. Treasury borrow money?By selling Treasury bills,

notes, and bonds, promising to make specified interest payments and to repay the loaned funds on a given date

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1920212223

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Federal Expenditures, Revenues, and Deficits as a Percentage of GDP

Federal Deficit

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Federal Budget Surpluses and Deficits

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What has been done to curb the National Debt?

• The Clinton plan• Line-item veto• Debt ceiling

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What was the keystone of the 1993 Clinton Deficit

Reduction Plan for Taxes?• Raised the highest

marginal tax rate from 31% to 36%

• Increased tax on gasoline by 4.3 cents per gallon

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What was the keystone of the 1993 Clinton

Deficit Reduction Plan for Spending?

Reduced military spending and and cut some entitlements, including Medicare, Medicaid, and food stamps

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What is a Debt Ceiling?The legislated legal limit

on the national debt

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What usually happens when the Debt pushes against the Ceiling?

Congress raises the ceiling to accommodate the budget deficit

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The National Debt as a Percentage of GDP

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What is the Internal National Debt?

The portion of the national debt owed to a nation’s own citizens

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What is the External National Debt?

The portion of the national debt owed to foreign citizens

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0%

20%

40%

60%

80%

100%

120%

An International Comparisonof National Debt Ratios as a percentage of

GDP, 1998

ItalyJapanCanadaFranceU.S.GermanyU.K.

2240 50 60 70 80 90 00

.05%1.0%1.5%2.0%2.5%3.0%3.5%4.0%

Federal Net Interest as a Percentage of GDP

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Ownership of the National Debt1998

37%

46%

17% Public Sector

Private Sector

Foreigners

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What is the Crowding-out Effect?

When federal government borrowing increases interest rates, the result is lower consumption and investments

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Can the Government go Bankrupt?

• Yes, it’s possible• No, the debt need never

be paid off

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Are we passing the Debt Burden to our Children?Yes, especially if it

continues to increaseNo, not as long as the debt

is internally owned

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Does Government Borrowing Crowd Out

Private-sector Spending?Yes, the more the government

borrows the less loanable funds for everyone else

No, especially if it occurs during economic downturns

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200

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2 4 6 8

AD1

AS

AD`2100

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AD2

E2

E1

E`2

Full Employment

Complete (AD1), Partial (AD`2), and Zero (AD2) Crowding Out

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Key Concepts

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Key Concepts• What is the Federal Deficit?

• What is the National Debt?

• How does the U.S. Treasury borrow money?

• What has been done to curb the National Debt?

• What is a Debt Ceiling?

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Key Concepts cont.• What is the Internal National Debt?

• What is the External National Debt?

• What is the Crowding-out Effect?

• Can the Government go Bankrupt?

• Are we passing the Debt Burden to our Children?

• Does Government Borrowing Crowd Out Private-sector Spending?

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Summary

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The national debt is the dollar amount that the federal government owes holders of government securities. It is the cumulative sum of past deficits. The U.S. Treasury issues government securities to finance the deficits. The debt has more than tripled since 1980. The debt ceiling is a method to restrict the national debt.

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Internal national debt is the percentage of the national debt a nation owes to its own citizens. In 1998, abut 83% of the national debt was internally held by individuals, banks, corporations, insurance companies, and government entities. The “we owe it to ourselves” argument over the debt is the U.S. citizens own the bulk of the national debt.

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External debt is a burden because it is the portion of the national debt a nation owes to foreigners. The interest paid on external debt transfers purchasing power to other nations. In 1998, approximately 17% of the national debt was external.

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Ownership of the National Debt1998

37%

46%

17% Public Sector

Private Sector

Foreigners

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The crowding-out effect is a burden of the national debt that occurs when the government borrows to finance its deficit, causing the interest rate to rise. As the interest rate rises, consumption and business investment fall.

The burden of debt debate involves controversial questions:

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Can Uncle Sam GO Bankrupt?

The national debt is a lower percentage of GDP today than at the end of World War II. The U.S. government will not go bankrupt because it never has to pay off its debt. When government securities mature, the U.S. Treasury can refinance or roll over the debt by issuing new securities.

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Are We Passing the Debt Burden to Our Children? NO

One side of this argument is that the debt is mostly internal, so financing a deficit only involves exchanging old bonds for new bonds among U.S. citizens. The burden of the debt falls only on the current generation when the trade-off between public-sector goods and private sector goods along the production possibilities curve occurs.

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Are We Passing the Debt Burden to Our Children? YES

The sizeable external debt transfers purchasing power to foreigners.

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Does Government Borrowing Crowd Out Private Sector Spending?

Keynesian theory assumes zero crowding out when the federal government increases spending in order to shift the aggregate demand curve rightward. If crowding out occurs, reduced private spending offsets the multiplier effect of increased government spending. As a result, the expected magnitude of the rightward shift in the aggregate demand curve is partially or completely offset.

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Chapter 23 Quiz

©2000 South-Western College Publishing

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1. During the late 1990’s, federal government budget deficits a. were completely removed.b. dropped significantly from a high of $300

billion.c. remained fairly stable at about $150 billion

per year.d. exceeded $200 billion in each year.

B.

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2. The federal government finances a budget deficit by a. taxing businesses and households.b. selling Treasury securities.c. printing more money.d. reducing its purchases of goods and services.

B. The U.S. Treasury borrows by selling Treasury bill (T-bills), notes, and bonds promising to make specified interest and repay the loan on a given date.

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3. In 1998, the national debt was approximately a. $60 billion.b. $600 billion.c. $6 trillion.d. $5 trillion.

C.

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4. The national debt a. doubled between 1950 and 1980, and by

1990, it was over four times its size in 1980.b. doubled between 1950 and 1980 and

doubled again between 1980 and 1990.c. stayed at approximately the same amount

between 1950 and 1980 and doubled between 1980 and 1990.

d. was four times larger in 1980 than it was in 1950 and then doubled between 1975 and 1990.

A.

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5. Which of the following countries has the smallest national debt as a percentage of GDP?a. Italy.b. Canada.c. United Kingdom.d. Japan.e. France.

C.

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0%

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60%

80%

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120%

An International Comparisonof National Debt Ratios as a percentage of

GDP, 1998

ItalyJapanCanadaFranceU.S.GermanyU.K.

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6. Which of the following is false?a. The national debt’s size decreased

steadily after World War II until 1980 and then increased sharply each year.

b. The national debt increases in size whenever the federal government has a budget surplus.

c. The national debt is currently is about the same size as it was during World War II.

d. All of the above are false.

D.

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7. In 1998, how much of the U.S. national debt was owed to foreigners?a. About 2.5%.b. About 17%.c. About 31%.d. About 59%.

B.

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8. Which of the following owns a portion of the national debt? a. Federal, state, and local governments.b. Private U.S. citizens.c. Banks.d. Foreigners.e. All of the above.

E. Treasury bills are widely held throughout the public and private sectors both domestically and overseas.

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9. The portion of the U.S. national debt held by foreigners a. represents a burden because it transfers

purchasing power from U.S. taxpayers to other countries.

b. is an accounting entry that represents no real burden.

c. decreased as a proportion of the total debt during the 1980’s.

d. has been constant for many decades.A. Approximately 17 percent of total U.S.

debt is external debt.

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Ownership of the National Debt1998

37%

46%

17% Public Sector

Private Sector

Foreigners

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10. Which of the following statements about crowding out is true? a. It is caused by a budget surplus.b. It is not caused by a budget deficit.c. It cannot completely offset the multiplier

effect of deficit government spending.d. It affects interest rates and, in turn,

consumption and investment spending.

D. The crowding-out effect is a reduction in private spending caused by federal deficits financed by U.S. Treasury borrowing.

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11. Which of the following statements about crowding out is true? a. It can completely offset the multiplier.b. It is caused by a budget deficit.c. It is not caused by a budget surplus.d. All of the above are true.

D. If crowding out occurs, reduced private spending offsets the multiplier effect of increased government spending. The debt is a summation of each years deficits and therefore effects consumption and investments. No crowding out occurs with budget surpluses because the government is not competing with consumers and investors for available funds.

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