chapter 13: government borrowing 13 - 1 chapter 13 government borrowing copyright © 2009 by the...

Chapter 13: Government Borrowing

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Chapter 13

Government Borrowing

Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin


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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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• Spending minus taxes in a given year

Deficit

• A flow that occurs during a period of time – one year

• The cumulative result of the deficits in prior years

Deficit versus Debt

Debt

• A stock that is measured at a point in time


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• 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…

Common Sense Concern about Excessive Borrowing

• Creditors may become wary

… excessive borrowing today means heavy payments to creditors tomorrow.

• There may be increased taxes or a cut in spending

• Inflation may occur if the government prints money


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• Children are not legally responsible for their parents’ borrowing

The burden of family borrowing

• In some cases, parents’ borrowing imposes a burden on children

The Burden of the Debt

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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Borrowing is inappropriate when government spending doesn’t benefit tomorrow’s taxpayers.

It depends.

• Current expenditures

Capital Expenditures

Is it fair to shift the burden of today’s government spending?

Borrowing is appropriate when government spending does benefit tomorrow’s taxpayers.

• Capital expenditures


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• r increases

Government Borrowing, Interest Rates, and the Crowding Out of Investment

• The government increases borrowing to finance spending

• Government borrowing crowds out private investment

Interest Rate (r)

D

S

Loanable Funds (F)

Figure 13.1

r0

D’

r1

F0 F1


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Disciplining Politicians with a Balanced Budget Rule

Spending must be entirely financed by tax revenue.

• The prohibition on borrowing and printing money

• The problem is that this rule may make a recession worse• FEBAR compared to NUBAR

An always balanced budget rule

• Politicians and citizens naturally demand excessive spending

• A balanced budget leads to optimal spending


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A planned balanced budget for next year is based on an estimate if next year’s unemployment rate is normal.

• Would provide discipline

A Normal-Unemployment Balanced Budget Rule

NUBAR

Questions

• How would it be implemented?

• Would avoid worsening a recession

• How would it be enforced?

• What about a recession or a war?


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Suppose $110,000 is promised next year and $100,000 of taxes is raised this year.

• It depends on the interest rate.

Fiscal Imbalance

Examples of long-term

fiscal imbalance

• Medicare

Is the $100,000 enough?

• Social Security

• Federal debt

The present value of future promised benefits( ) The present value of

future assigned taxes( )=


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Generational Accounting

…focuses on how each generation fares with respect to government taxing and spending

• Some generations get a better or worse deal from government taxing and spending

Examples

• First public schools

• Social Security

The present value of benefits it receives( ) The present value

of taxes it pays( )=


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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%

U.S. Treasury Debt Held by the Public and by U.S. Government Agencies


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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%

The Interest Burden of the U.S. Treasury

• Net debt as a percent of GDP

• Bond interest rate

Consequences for the interest burden

Source: CBO, The Budget and Economic Outlook: Fiscal Years 2008 to 2018 (Jan. 2008), Table F-2 and F-6


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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%

The Deficit, Debt, and Interest as a Percent of GDP

b* = f/g

i* = rb* = r(f/g)


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Inflation, Debt, and Deficits

Real surplus

Real deficit

= (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)

= (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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Generating Inflation

Combined fiscal-monetary stimulates the economy

• 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

Separation of powers

• Which raises aggregate demand for goods and services above supply

• Which causes prices to rise – inflation


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Generating Inflation

• Excess demand raises inflation

Deficits and inflation

• Deficits can cause inflation

• Deficits do not have to generate inflation

Do deficits directly cause inflation?

• Deficient demand reduces inflation


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The Long-Term Budget Outlook for the U.S.

Figure 1.11% of GDP

24%

23%

22%

20%

19%

18%

1965 1970 1975 1980 1985 1990 1995 2000 2005 Year

Federal Spending

21%

17%

16%

Federal Taxes

• Average federal spending ~ 20% of GDP

• Average federal revenue ~ 18% of GDP


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The Long-Term Budget Outlook for the U.S.

Figure 1.12

% of GDP

50%

45%

40%

35%

30%

25%

1965 1970 1975 1980 1985 1990 1995 2000 2005 Year

Federal Debt

• Average federal deficit ~ 2% of GDP


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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.

chapter 13: government borrowing 13 - 1 chapter 13 government borrowing copyright © 2009 by the...

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