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Government Debt Paper

Government Debt Paper

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Published by calibrateconfidence

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Published by: calibrateconfidence on Feb 21, 2012
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Using a data set on government debt that was previously unavailable, the article analyzes who bears the burden o government debt. The database includes 12 countries with bothdebt and GDP data on the countries stretching back over a century. The paper showsthat in addition to the level o the Debt/GDP ratio, anticipated uture changes in thisratio, as well as the interest cost o covering the debt are important variables aectingthe economy. Most nations have seen their government debt/GDP ratio exceed 100%in the past, but not all have sparked a nancial crisis. The impact o the governmentdebt/GDP ratio also depends upon the causes, whether the increase is short-term dueto war or economy fuctuations, or secular due to ununded increases in governmentspending. Reducing the Debt/GDP ratio is a political decision. The government mustdecide to reduce it by reducing compensation to government employees, recipients o government unding, through higher taxes, or an outright or infationary deault.
Paying offgovernment debt
Tw Cetures f G Experece
Dr. Bryan Taylor, Chief Economist,Global Financial Data 
Global FinanCial DaTa
 
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The current economic recession has led tounprecedented peacetime decits and increases ingovernment debt in developed countries. For only the second time in the history o the United States,government debt will soon exceed GDP. The long-runcosts and the impact o this growing debt remainshighly uncertain and is the chie topic o politicaldebate in the current US elections. While the WhiteHouse says these decits are necessary despite thecosts, others say the debts impose costs on uturegenerations. Tea Party supporters say governmentexpenditure must be cut.Unortunately, very little is known about the historicallevels o government debt or dierent countries o the world outside o the United States and how dierentcountries have dealt with large levels o governmentdebt in the past. Global Financial Data has collectedhistorical government debt and GDP data or themajor world economies going back to the 1800s. Thispaper is based upon the ndings o this research.
The Origin o Government Defcits
The government runs a decit because it is unable orunwilling to collect a sucient amount o taxes withinany given year to cover its expenditures. For mosto its history, the United States balanced its budgetexcept in war time. Ater the war, the governmentran surpluses to pay down the debt accumulatedduring the war or ran decits less than the growth innominal GDP. A long-term graph o US debt on page23 shows rises in the Debt/GDP ratio during the Waro 1812, Civil War, World War I, and World War II.The true cost to the economy o government isthe expenditures it makes, not the taxes it collects.Government can either collect taxes today or issuepromises (currency or bonds) to pay or its purchasesin the uture. When the government increases themoney supply, it can cause infation, and i it issues bonds, it can “crowd out” the private sector.Running decits implies less spending in the uturesince the government must pay interest or retire bonds. In some cases, short-run decits can be justied. Just as consumers or businesses may wishto smooth out the cost o consumption over time,so can government. I the government is buildinginrastructure which has long-term benets, it may  borrow money today to be paid o in the uture.Similarly, the government may run a cyclical decitduring a recession which it can pay o when theeconomy recovers.Structural decits are another matter. A structuraldecit that is used to pay or services or transerincome, unlike capital investment, does not add tothe net wealth o society, and implies higher taxesor lower government services in the uture to osetthe accumulated structural decits. As Robert Barrohas shown, these types o structural decits can havemultipliers less than one because o their impact onincentives and the economic misallocations they create. Unortunately, a portion o the current decitthe US is running is structural in nature.A structural decit implies structural adjustmentsin the uture; however, it may be dicult to generatethe uture surpluses needed to pay o this debt ordemographic reasons. An aging population implies both a higher recipient to taxpayer ratio, and higherhealth care costs or the elderly. Calculations o the implied cost o the entitlement programs the
 
3| Pyg off Gvermet DetGlobal FinanCial DaTa
government has promised in the uture, such as SocialSecurity, Medicare, Medicaid and other programs,predict large increases in these costs in the uture without large reductions in the promised benets.Any attempt to run surpluses to pay back the debt will require large increases in taxes.
Paying o the government debt
Paying o the debt is largely a political choice. Who bears the cost o paying o the debt? Is it government workers through lower pay and lower benets? Isit individuals who see a reduction in governmentservices or entitlements, either directly through cutsor indirectly through slower growth in benets?Is it taxpayers who pay higher taxes and ees? Arethe additional taxes born by the rich or the poor or both? Is it bondholders who get paid back in infatedcurrency or don’t get paid back at all?Government debt as a share o GDP can be reducedor eliminated in a number o ways.1. Run surpluses and pay o the debt as happenedin the US in the 1830s, or reduce the debt/GDP ratio by running surpluses as occurredaround 2000 under Bill Clinton. Here the costo the debt is imposed directly on taxpayers with no loss to xed income investors.2. Run a decit that is less than the growth in nominalGDP so even i you continue to run a decit, thedebt/GDP ratio shrinks. The government may have to run a surplus beore interest payments inorder to achieve this. The lower the interest rate, theeasier this is to do. This is largely what happenedin the United States between 1945 and 1973. Thisimposes a lower cost on taxpayers in the short-run, but raises the total cost o debt over time.3. Infate your way out o the debt. I the infationrate is high enough, nominal GDP can grow asterthan the decit reducing the debt/GDP ratio. Thisimposes high costs on bondholders who get paid back in infated currency, but relieves taxpayers o the burden. A hyperinfation as in Germany can wipe out xed income investors. This relievestaxpayers o the interest and principal burden o thedebt, but at a high cost to xed income investors.This solution works well with non-recurringdebt (wars), but not with secular social debts.4. Outright Deault. This can be done througha currency reorm i most governmentdebt is held domestically (Germany, 1948),devaluation i the debt is held by oreigners butin the local currency, or a deault on oreigncurrency bonds. Here the entire cost is born by bondholders to the benet o taxpayers, but it becomes dicult to issue new bonds.Just as the purpose o running a decit is to hide thecost o government services and expenditures throughindirect taxation (infation tax) or delaying the costs(issuing bonds), so the goal o the government inpaying down the debt will be to make the cost asindirect as possible, or to impose the costs on those without political power.The rest o this paper will look at the experience o twelve major economies to see how they have createdand paid o decits in the past. Each country’sexperience could be the subject o a book, so only the barest o outlines is possible. Nevertheless, these brie histories and their subsequent graphs will givean idea o the choices the major developed countriesnow ace. We will look at both the debt/GDP ratio andInterest Share o GDP which equals the benchmark bond interest rate times the debt/GDP ratio.Historically, there have been several actors whichhave caused increases in the debt/GDP ratio. One is war. Globally, the primary examples are World WarI and World War II. The two wars were “paid or”dierently.

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