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 lebt? * 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 governmenttrust fund (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 Bede eee ce ee ees Boel Be“> 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Nominal interest Rate on Federal Debtvs. ‘Growth Rate of Potential Nominal GOP PLSLIDELS Source FRED ~> As the examples show, the risk that the debt will grow without limit at an ever faster rate exists only when the rate of interest is greater than the rate of growth of potential GDP ~ Economists have long thought that is the normal case. As this chart shows, in the US, from 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 PEL IIL ILI PLS~ 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