The Public Debt difference between Deficits and Debt - Deficits occurs when federal government spending is greater t! tax revenue in a single fiscal year. - Debtis the cumulative total of all the federal budget deficits les any surpluses. =xample: » Suppose that our deficit declined one year from $200 billion to $150 billion. : The national debt would still go up by $150 billion. : So every year that we have a deficit—even a declining one the national debt will go up.Vhat’s the difference between deficits and jebt? : Deficits: The annual imbalance between revenues ar spending - Debt: The accumulation of deficits over time * Public debt: Federal government securities held by Americans and foreigners * Intragovernmental debt: Held by government trustfund (e.g., Social Security) and other accounts Vhat are “unfunded liabilities”? - Benefits (e.g., Social Security or Medicare) that have been promised to be paid in the future, with no“> The government debt is the total amount that the government owes to members of the public ~ The budget balance is equal to govemment revenues Minus expenditures. a negative number when there is a deficit and a positive number when there is a surplus ~> Each year the debt changes by the amount of the budget balance > lithere S42 deficit, the government borrows. more and the debt increases % Ifthere ¢ 2 surplus, the goverment pays off Ookd borrowing and total debt decreasesThe Bottom Line + As of 2015, the primary structural balance is high enaugh to bring the debt ratio down gradually + Ifthere are no policy changes, demographic factors will cause the debt ratio to grow gradually toward a moderately higher limit after 2019 ~ Renewed growth rate of the debt ratio after 2019 could be reversed by increases in taxes or reductions in spending totaling less than 1 percent of GDP ~ The bottom line: Available evidence does ‘not support the view that the federal debt, given current policies, is growing out of control in a way that endangers America’s futureWill the Debt Continue to be Sustainable? ~> Although the CBO forecasts a decrease in the debt ratio in the immediate future, it expects the debt ratio to begin rising again after 2019 ~> By 2025, the forecast for the current PSB is about -0.7% of GDP compared to a forecast steady state value of -0.8% of GDP ~> Reasons for renewed growth of the debt: > Growth of mandatory outlays due to an aging population and other factors ~ Increase in real interest rate <> Slowing growth of real potential GDP ~> However, interest rates are expected to stay below GDP growth, so growth of the debt ratio should remain limited2 Is the US Federal De ~ Each year the Congressional Budget Office issues a budget outlook with estimates of all parameters of our model ~ As of 2015, the CBO estimates a current budget balance of -2.6% of GDP, a structural balance of -1.9%, and a primary structural balance of -0.6% <> The estimated steady-state PSB for 2015 is -1.7% ~ The federal debt is sustainable given those numbers, since the current PSB for 2015 is greater than the steady-state value (-0.6 > -1.7)~> From 2002 through 2015, interest fates averaged 0.8 percentage points below potential GDP growth, and 1.2 percentage points lower in the most Tecent 5 years ~ Some economists are beginning to think ultra-low rates may be the new normal, citing factors like China's slowdown, a world-wide savings glut, and chronic low inflation (or even deflation) in Japan, the EU, and the US ~ Interest rates lower than GDP growth greatly reduce the risk of explosive debt growth Nominal interest Rate on Federal Debtvs. ‘Growth Rate of Potential Nominal GOP PLSLIOELS Source FRED LIESPPPLELISNominal interest Rate on Federal Debtvs. ‘Growth Rate of Potential Nominal GOP + Incontrast, from 1965 through 1981, the growth of nominal potential GDP averaged 4.4 percentage points above than the interest rate on the debt. ~ During that period, inflation constantly accelerated. It seems plausible that chronic underestimation of future inflation kept interest rates abnormally low (compared with rapid nominal GDP growth) during those years PEL III LIPS~ As the axamples show, tha risk that the dept will grow without limit at an aver fastar rate azists only whan the rate af interest is greater than the rata af growth of potential GDP ~ Economists have long thought that is the normal case. As this chart shows, inthe US, fram 1982 through 2001, the nominal interest rate on the federal debt averaged 1.1 percentage points higher than the growth rate of potential nominal GDP Ripeminal interest Rare pts | eckeeal [mebe es, SGeoweth fase of Popeedial teominal te PURE me BBE Ri S LESPPEPEL ES~ In Example 2, the interest rate (0.02) is less than the rate of GDP growth (0.04) ~ Ifthe PSB is too small (e.g. —0.015 instead of the steady state value of —0.01, the debt ratio will grow toward a new steady-state value, in this case 0.75 +> Ifthe PSB is larger than the steady state value (e.g. — .005), the debt ratio will decrease to a new steady- state value, in this case 0.25 Dynamics of Debt as % of GDP eo% , DEBT=0.5 INT=0.02 GRO=0.04 on PSB= -.015 10% ox ss 0% — nm 2% 10% PSB= -.005 Year om © 10 20 30 40 50 60 70 80 90 100+ In Example 1, the interest rate (0.04) is greater than the rate of GDP growth (0.02) ~ If the PSB is less than the steady- state value of 0.01 (e.g. 0.005) the debt ratio will grow without limit at an ever increasing rate + if the PSB is greater than the steady state value (e.g. 0.015), the debt ratio will decrease without limit. + (Anegative net debt ratio means the government has financial assets that exceed its financial liabilities, as in Norway and some other oil-rich countries) 100% Dynamics of Debt as % of GDP DEBT=0.5 INT=0.04 GRO=0.02 200% PSB=.005 150% > 100% | 50% p 10 20 30 40 so GOED 80 90 100 50% PSB=.015 150%Example 1: The Math + If there is a constant primary structural surplus of 1% of GDP, the debt ratio will remain constant at 50% of GDP Example 1 + If PSB <1% (a smaller surplus + DEBT =0.5 of a deficit) the debt will grow +> INT = 0.04 + If PSB>1% the debt will shrink ~> GRO = 0.02 +> Total interest payments (INT PSB" = 0.5(0.04-0.02) = +0.01 times DEBT) will be 2% of GDP, so stability of the debtimplies an overall structural balance, including interest of -1% (a structural deficit)The Steady-State Pr ~> Under any given conditions, there is some primary structural balance just sufficient to hold total government debt constant as a share of GDP ~> We will call that the steady-state value of the PSB, or PSB* ~> The panel at the right shows how to calculate PSB* given the debt ratio, the interest rate on the debt, and the rate of growth of GDP~ This figure shows the three US government budget balances for 2000-2015 ~ Ina recession year (e.g. 2009) the current balance is below the structural balance (larger deficit) ~> Near the peak of the cycle the current balance is above the structural balance (smaller deficit, as in 2006, or larger surplus, as in 2000) + The primary structural balance is always above the current structural balance by a distance equal to interest on the debt US Budget Balances 1990-2015 Percentot GOP 2 15112345eum: OFCDjam meee at teeis otgowerrmertThe Primary $ «> The primary structural balance (PSB) is equal to the overall structural balance excluding interest payments on the govemment debt ~ As we will see, the PSB is a key indicator of long-run debt trends~> The current balance of the budget is the measured value each year of taxes minus expenditures ~> The structural balance (sometimes called the cyclically adjusted balance) is the current balance minus the contribution of automatic stabilizers ~ The structural balance shows what the budget balance would be under current laws in force if the output gap were zero, that is, ifthe economy were at full employment Surplus ‘Contribution of Automatic stabilizers~ Automatic stabilizers are line items ae that automatically move the budget ‘Contribution of balance toward deficit when the output ‘Aetomeic stabilizers gap is negative and toward surplus when it is positive, even if there are no changes in tax or spending laws ~ Examples: ~> Income tax revenues increase when the economy expands, pushing the balance toward surplus ~> Unemployment benefits increase when the economy is in recession, pushing the balance toward deficit~+> Next, to identify long-run debt trends, we need adjust for the effects of the business cycle + Key terms: ~ Potential GDP is the total output thatthe economy could produce if it ‘were operating at full employment ~ The output gap is equal to current GDP minus potential GDP, usually Stated as a percent of potential GDP ~> The output gap is negative at the bottom of a recession and positive at the peak of a boom> The government debt is the total amount that the government owes to members of the public > The budget balance is equal to government fevenues minus expenditures, a negative number when there is a deficit and a positive number when there is a surplus ~ Each year the debt changes by the amount of the budget balance + Ifthere is a deficit, the government borrows more and the debt increases + Ifthere is a surplus, the government pays off old borrowing and total debt decreaseshe reduce fiscal deficits, the government i aly to use a combination of policies. A k tor is the timing of deficit reduction ins. If the country is already in recessio! 3 much more difficult to reduce the def cause fiscal consolidation tends to rsen the economic situation leading to ver tax revenues. In some cases, auster 1 even be self-defeating. 2 best way to reduce the budget deficit aim for positive economic growth, but i » long-term evaluate government 2nding commitments and reduce 2nding to sustainable levels. lated e ls Austerity self-defeating? site uses cookies so that we can remember yo use our site and serve you relevant adverts andefault netimes countries have got to the stag ere they can't manage their budget ficit. Arguably Greece is very close. The vernment have tried spending cuts and - increases, but the budget deficit rtinues to be large. Also, the fiscal isolidation has caused an economic oression. Therefore, they may be bette defaulting, leaving the Euro and startir ain. Should Greece leave the Euro? In tr st countries, such as Argentina and ssia have defaulted. The problem with faulting is that it destroys the savings 0 ‘estors, and will make it difficult to rrow again from capital markets. site uses cookies so that we can remember yo use our site and serve you relevant adverts andsome circumstances, countries can be zible for a bailout from an international Zanisation, such as the IMF. This means »y can draw on temporary funds to helt th temporary liquidity shortages. The ilout may reassure investors and give tt intry more time for dealing with the ficit. For example, in the 1970s, the UK olied for bailout funds from the IMF. A ilout usually comes with strict tructions on reducing the deficit - this \y be politically easier when it is enforce m the outside. However, in the case of /erely indebted countries, a bailout ma’ insufficient to deal with the underlying el of debt. Also, bailout conditions can ‘hly controversial. efault site uses cookies so that we can remember yoe of the best ways to reduce the budge ficit as a % of GDP is to promote ynomic growth. If the economy grows, 2n the government will increase tax renue, without raising taxes. With ynomic growth, people pay more VAT, npanies pay more corporation tax (tax profits), and workers pay more income .. High economic growth, is the least inful way to reduce the budget deficit cause you don't need to raise tax rates : spending. However, many countries ‘h fiscal deficit crisis are often stuck in ‘ession. Countries in the Eurozone ‘rently find it difficult to grow because ¢ » nature of European monetary policy d the constraints of the Euro. Also, ynomic growth may not solve the derlying structural deficit (which occurs 2n during high growth) This may stillTax increases ther taxes increase revenue and help tc Juce the budget deficit. Like spending ‘s, they could cause lower spending anc d to a fall in economic growth. Again it oends on the timing of tax increases. Ir ‘ession, tax increases could cause a nificant drop in spending. During high ywth, tax increases won't harm spendin much. It also depends on the type of te J increase. Recently, France increased ‘es on the rich to over 70% - however, ne have complained this is too high an ‘ates disincentives to work in France. If ‘h marginal tax rates do reduce incentiy work, the tax revenue raised may be le: in planned. See: French economic site uses cookies so that we can remember yo use our site and serve you relevant adverts and—— ee EE NEE IES EEE EEE el ee o: Eurozone austerity. her Evaluation of Cutting Governme! ending lepends on the type of government 2nding you cut. If you cut pension 2nding (e.g. make people work longer), 2n there may be an actual increase in ductive capacity. If you cut public sect« estment, it will have a bigger adverse ect on aggregate demand and the supr e of the economy. Therefore, the nptation is for the government to cut nefits and pensions as this can reduce 2nding with less impact on economic ywth - but it will be at the cost of reased inequality in society. Tax increases site uses cookies so that we can remember yo use our site and serve you relevant adverts and