Budget Deficits and the National Debt Fiscal Policy

Budget Deficits and the National Debt Fiscal policy is the taxing and spending used by the federal government to make changes in the economy. It can be used to help stimulate demand, increase production, create jobs, increase GDP, avoid recessions, control inflation, and stabilize economic growth. Raising government spending can lead to enormous debt. The cost of this debt must be measured against the benefits of higher government spending.

Key points to think about Balancing the Budget The National Debt Is the Debt a Problem?

Balancing the Budget The basic tool of fiscal policy is the federal budget It is made up of two parts Revenue (taxes) Expenditures (spending programs)

Balancing the Budget A balanced budget is when the federal government’s revenues equal its expenditures in any particular year.

Balancing the Budget The federal budget is almost never balanced. It is usually running in either running a surplus or a deficit. Budget Surplus – Government takes in more than it spends. Budget Deficit – Government spends more than it takes in.

Balancing the Budget When the government runs a deficit, that means it did not take in enough revenue to cover its expenses for the year. It must then find a way to pay for the extra expenditures. There are two basic actions to take. Create Money Borrow Money

Creating Money The government could just create money to pay its workers. They traditionally would just print more bills but today it makes more sense to do this electronically. This has the same effect. What problems can this cause?

Hyperinflation Covering very large deficits by printing more money can cause very high inflation called hyperinflation. This happened in Germany and Russia after WWI Brazil and Argentina in the 1980’s Ukraine in the 1990’s

Well…. I guess we could just borrow some money.

Ways to borrow money… Treasury bill Treasury note Treasury bond A government bond that is repaid within three months to a year Treasury note A government bond that is repaid within two to ten years Treasury bond A government bond that can be issued for as long as 30 years

Crowding-out Effect The problem with the national debt and borrowing money is that every time the government borrows money they have to pay it back. They pay it back with high interest rates to attract buyers They money they use to pay the loans back now cannot be used in supporting businesses and this is known as the crowding-out effect.

Creating Money Demand INFLATION Prices Rise Gov’t creates money Increases demand for goods and services Increases money in circulation Demand Output increases Demand rises Prices Rise Increase in $ means more $ but same amount of goods & services Increased output Full Employment INFLATION

Borrowing Money The government can borrow money to cover a budget deficit. They do this by selling bonds. Federal borrowing lets the government undertake more projects than it could otherwise afford. Building airports, highways, national parks. Wise borrowing allows the government to create more public goods and services.

The National Debt

The National Debt The problem with borrowing money is that it creates a national debt. Every year that there is budget deficit, and the feds borrow money to cover it, the national debt will grow. Current National Debt

The National Debt The national debt is owed to investors who hold Treasury bonds, bills, and notes. If you have a federal savings bond, that bond represents money you have loaned the government

The National Debt Bonds issued by the United States federal government are considered to be one of the safest in the world. Because the U.S. federal government is widely viewed (until recently) as stable and trustworthy, the federal government can borrow money at a lower rate of interest than private citizens or corporations can. Lower interest rates benefit taxpayers by reducing the cost of government borrowing.

(This was recently downgraded) The National Debt The United States Global Credit Score is AA+ Stable (This was recently downgraded)

The National Debt What is the difference between deficit and debt? Deficit is the amount of money the government borrows for one budget, representing one fiscal year Debt is a sum of all government borrowing up to that time

Historically… National debt as a percentage of GDP rises during wartime, when government spending increases faster than taxation, and falls during peacetime.

Is the debt a problem? Two problems can come from the national debt It reduces the funds available for businesses to invest. If businesses spend money on the buying bonds than they have less to use to expand their factories, conduct research, and develop new products The government has to pay interest to bondholders. The more a government borrows the more it has to pay back!

Opportunity cost… The problem with servicing the debt is that dollars spent on the debt cannot be used on other things, like defense, health care, or infrastructure.

What would Keynes say! Today, many economist think the role of the federal government in the economy should be limited.

Question: What is one of the major problems caused by a large national debt? It decreases the amount of money available to be borrowed by businesses.

Question: What was the state of the federal budget at the start of the 21st century? Surpluses for the first time in 30 years

Question: What can be expected when members of the baby boom generation begin to retire in large numbers? Increased deficits

Last one… What is the major argument against a constitutional amendment requiring a balanced budget? It would be too inflexible