politics, deficits, and debt deficit and debt. the definition of debt and assets debt is accumulated...
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POLITICS, DEFICITS, AND DEBT
Deficit and Debt
The Definition of Debt and Assets
• Debt is accumulated deficits minus accumulated surpluses.
• Deficits and surpluses are flow concepts.
• Debt is a stock concept.
Debt Management
• The U.S. Treasury must sell new bonds when running a deficit and refinance previously issued bonds as they come due.
The Need to Judge Debt Relative to Assets
• Debt needs to be judged relative to assets.
• Debt is a summary measure of a nation’s financial situation.
• As a summary measure, debt has even more problems than deficit.
The Need to Judge Debt Relative to Assets
• Debt by itself is only half the picture.
• The other half is assets.
The Need to Judge Debt Relative to Assets
• For a nation, assets include:
– Its skilled work force.– Natural resources.– Its housing stock.– Holdings of foreign assets.
– The buildings and land it owns.– A portion of the assets of the people in the
country, since government gets a portion of all earnings of those assets in tax revenue.
The Need to Judge Debt Relative to Assets
• For a government, assets include:
• If the assets are valued at more than their costs, then the deficit is making the society better off.
The Need to Judge Debt Relative to Assets
• When the government runs a deficit, it might be spending on projects that increase its assets.
• These assets earn money in the future for the business.
The Need to Judge Debt Relative to Assets
• When businesses spend on projects that increase its assets, such expenditures are included in a capital budget.
• Determining what is an investment in government is extraordinarily difficult.
The Need to Judge Debt Relative to Assets
• Government does not have a capital budget.
• Thus, government avoids trying to measure the capitalizing aspects of spending.
The Need to Judge Debt Relative to Assets
• Most government goods earn no income, they are supplied free to individuals and are paid for by taxes.
Arbitrariness in Defining Debt and Assets
• Defining debt and assets can be arbitrary.
• As was the case with income, revenues, and deficits, there is no perfect answer as to how assets and debt should be valued.
Arbitrariness in Defining Debt and Assets
• Even after assets are taken into account, you still have to be careful when deciding whether or not to be concerned about debt.
• The government holds about 44 percent of its own debt, most of it in the Social Security trust fund.
Arbitrariness in Defining Debt and Assets
• Much of the government debt is internal to the government.
Difference Between Individual and Government Debt***
• Government debt is different from an individual’s debt for three reasons:– Government debt is ongoing – it does not
die.– Government can print money to pay off its
debt – individuals can’t. – 82 percent of government debt is internal
debt – debt owed to other government agencies or to its citizens.
Arbitrariness in Defining Debt and Assets
Federal Reserve (9%)
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Foreign individuals and firms (25%)
U.S. individuals and firms (24%)
U.S. government agencies (42%)
Ownership of Debt
Federal agencies
17%Social Security 13%Federal Reserve 9%
State and localgovernments 8%
Public Sector
Foreigners
Foreigners 20%
Private Sector
Individuals6%Banks,
corporations,insurance
companies,etc, 8%
Difference Between Individual and Government Debt***
• Paying interest on the internal debt involves a redistribution among citizens of the country.
• It does not not involves a net reduction in income of the average citizen.
• External debt – government debt owed to individuals in foreign countries.
Difference Between Individual and Government Debt**
• External debt is more like an individual’s debt.
Government Deficits and Debt: the Historical Record
• The government has run almost continual deficits from World War II until now, except for a few years in the late 1990s.
• Deficits as a percentage of GDP did not rise significantly in the 1970s and 1980s.
• Debt relative to GDP has not been continuously increasing.
• Deficits and debt relative to GDP provide a measure of a country’s ability to pay off a deficit and service its debt.
A String of Deficits
1970 1994 1996 1998 2000 200219721974 19761978 1980 198219841986 198819901992
Budget Surpluses
Budget Deficits
10%
0
-10
-20
-301900 1920 1940 1960 1980 2000
Budget Deficits as a Percentage of GDP
Always in Debt
• 1835-36: Debt Free! – The U.S. was completely out of debt by 1835.
• The Mexican-American War (1846-48) caused a four-fold increase in the debt
Debt as a Percentage of GDP
100%
75
50
25
01800 1920 1940 1960 1980 20001820 1840 1860 1880 1900
The Debt Burden*
• Most of the decrease in the debt-to-GDP ratio occurred through growth of GDP.
• Real growth in the U.S. has averaged about 2.5 to 3.5 percent per year.
• This means that U.S. debt can grow between 2.5 to 3.5 percent a year without increasing debt/GDP ratio.
The Debt Burden
• Most of the decrease in the U.S. debt-to-GDP ratio occurred through growth in GDP.
• When GDP grows, the government can reasonably handle more debt.
U.S. Debt Compared to Foreign Countries’ Debt
Interest Rates and Debt Burden
• The interest rate determines annual debt service.
• The annual debt service is the interest rate on debt times the total debt.
Interest Rates and Debt Burden
• Interest payments on the debt is government revenue that cannot be spent on defense or welfare.
• That is what people mean when they say a deficit is burdening future generations.*
Interest Rates and Debt Burden
• The U.S. can actually afford more debt since U.S. government securities are considered the safest in the world.
Nominal and Real Surpluses and Deficits
• Inflation reduces the value of the debt.
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• That reduction is taken into account when the real deficit is calculated.
Nominal and Real Surpluses and Deficits
• A nominal deficit is determined by looking at the difference between expenditures and receipts.
• A real deficit is the nominal deficit adjusted for inflation.
Nominal and Real Surpluses and Deficits
• The real deficit is calculated by adjusting the nominal deficit for inflation.
Real deficit = Nominal deficit – (Inflation x Total debt)
Nominal and Real Surpluses and Deficits
• The lowering of the real deficit by inflation is not costless to the government.
• Persistent inflation gets built into expectations and causes higher interest rates.