Chapter 15 government debt budget deficit
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Chapter 15: Government Debt & Budget Deficit. Deficit & Debt. Federal deficit occurs when government spending (purchases & transfers) exceeds tax receipts Federal debt is the amount of funds the government must borrow to cover its deficit

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Chapter 15: Government Debt & Budget Deficit

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Chapter 15 government debt budget deficit

Chapter 15: Government Debt & Budget Deficit


Deficit debt

Deficit & Debt

  • Federal deficit occurs when government spending (purchases & transfers) exceeds tax receipts

  • Federal debt is the amount of funds the government must borrow to cover its deficit

  • Money is owed to government agencies, private individuals and firms, and foreign individuals, companies, and countries


Size of debt

Size of Debt

  • Size of the debt is measured by the debt ratio: government debt as a percentage of the GDP

  • Debt ratio in U.S. in 1998 = 65, less than Belgium (125), Italy (123), and Japan (93), but more than Australia (40), Finland (59) and U.K. (60)


The debt gdp ratio

The Debt-GDP Ratio


The debt gdp ratio us

The Debt-GDP Ratio (US)


Change in debt ratio

Change in Debt Ratio

  • Revolutionary War = 45

  • Civil War = 40

  • WW I = 40

  • WW II = 120

  • In recent years, the ratio increased from 22 in 1970 to 40 in 1980 to 60 in 1990 and to 65 in 1998


Deficit debt projections

Deficit & Debt Projections

All variables are expressed as percentage of GDP


Deficit debt projections1

Deficit & Debt Projections

  • Receipt shall stay constant at 20%

  • Spending shall rise from 21% in 2000 to 22% in 2030 to 43% in 2050

  • Deficit shall rise from –1% in 2010 to 23% in 2050

  • Debt falling to 17% in 2020 shall rise to 93% in 2040 and 206% in 2050


Measurement problem 1

Measurement Problem 1

  • Calculating deficit in “nominal” value results in an overstatement of the amount of debt required to cover the deficit

  • Deficit and debt must be expressed in “real” values; i.e. adjusted for inflation


Measurement problem 2

Measurement Problem 2

  • Unlike private accounting procedures, government debt does not measure the difference between government assets and liabilities

  • Capital budgeting, that accounts for assets and liabilities, measures changes in capital


Measurement problem 3

Measurement Problem 3

  • Government debt does not account for Social Security liabilities

  • Unlike public debt, the government can refuse making Social Security payments if funds are insufficient


Measurement problem 4

Measurement Problem 4

  • Deficit and debt move pro-cyclically: they fall during a slump and rise during a boom

  • To solve this problem, the government calculates a “cyclically-adjusted” budget deficit, which the amount of deficit at full employment


Traditional view of debt

Traditional View of Debt

  • A tax cut increases disposable personal income, consumption spending, employment, and income. A higher AD results in higher income and real interest rate as the IS curve shifts to the right.

  • In the long-run, price level will rise, lowering SRAS to reduce income to its full employment level


Ricardian view of debt analysis

Ricardian View of Debt: Analysis

  • Forward-looking consumers may not spend their additional disposable income to cause growth

  • With a tax cut, people shall expect a future spending cut as the government would not want to run a deficit

  • Likewise, consumers view debt accumulation as a sign of higher future taxes, thus saving money for that purpose


Ricardian view of debt case study

Ricardian View of Debt: Case Study

  • In early 1992, President Bush reduced the federal income tax withholding requirement to increase disposable income and stimulate growth

  • Forward-looking consumers expecting larger tax liabilities in April, did not spend the additional income to help the economy grow


Ricardian view of debt burden

Ricardian View of Debt: Burden

  • Parents learning that debt operates as a negative future transfer payment, would not spend as much during their lifetime

  • Parents save and accumulate assets to pass money on to their children and grand children


Position of the fed

Position of the FED

  • A substantial reduction in long-term prospective deficit will significantly lower long-term inflation expectations

  • Inflationary financed growth results in increased tax revenues and government spending to cause deficit and inflation

  • Deficit financed growth increases debt with no real income growth, but higher inflation


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