Macroeconomics For Social Negotiators

Public Deficit and Debt Gustavo Rinaldi Ph.D.

Government Surplus or Deficit Government Surplus or Deficit General Government Net Lending (+) or Net Borrowing (-) Deficitt = i Bt-1 + Gt – Tt

Budget Deficit . i = interest rate Bt-1 = debt on december 31st of the ______previous year

General government net lending/borrowing

General government net lending/borrowing

1 + i = 1 + r 1 + p Real interest rate p Is the inflation rate i Is the nominal interest rate

Inflation Adjusted Budget Deficit . r = real interest rate Bt-1 = debt inherited from the previous year

Inflation Adjusted Budget Deficit Deficit = r Bt-1 + Gt – Tt Deficitt = interests + primary deficit

interests on the debt r Bt-1 real interest payments i Bt-1 nominal expenditure

i Bt-1 /GDP

Primary Budget Deficit Gt – Tt Gt it does not include monetary transfers (pensions, benefits, subsidies to firms, etc.). T includes taxes and transfers (T = net taxes)

General government primary net lending/borrowing

General government primary net lending/borrowing

Sources of government funding Taxes Sales of public assets Dividends from state owned firms Borrowing Printing money

Sources of government funding Taxes Sales of public assets Dividends from state owned firms Borrowing Printing money

Government sells bonds To the CB : Monetary Finance To private: Debt Creation We assume that only creates debt.

Deficits create and increase Debts Bt - Bt-1 = r Bt-1 + Gt – Tt

Deficit creates and increases Debt Bt - Bt-1 = r Bt-1 + Gt – Tt Bt = r Bt-1 + Bt-1 + Gt – Tt Bt = (1+r) Bt-1 + Gt – Tt

In general B1 = (1+r) B0 + G1 – T1 If B1 = B0 B0 = (1+r) B0 + G1 – T1 Stabilization In general B1 = (1+r) B0 + G1 – T1 If B1 = B0 B0 = (1+r) B0 + G1 – T1

interests = primary surplus Stabilization in this case B0 = B0+B0r + G1 – T1 0 = B0r + G1 – T1 B0r = T1 – G1 interests = primary surplus

Which resources we use to serve the il debt? GDP mainly

B t = (1+r) Bt-1 + Gt – Tt_ Yt Yt Yt Debt / GDP B t = (1+r) Bt-1 + Gt – Tt_ Yt Yt Yt

(gross) Debt / GDP

B t = (1+r) Bt-1 + Gt – Tt_ Yt Yt Yt Debt / GDP B t = (1+r) Bt-1 + Gt – Tt_ Yt Yt Yt Multiply by Yt-1/ Yt-1 = 1

B t = Yt-1(1+r) Bt-1 + Gt – Tt_ Yt Yt Yt-1 Yt Debt / GDP B t = Yt-1(1+r) Bt-1 + Gt – Tt_ Yt Yt Yt-1 Yt

Debt / GDP Yt-1 = 1 Yt 1 + gy gy = GDP growt rate

B t = (1+r) Bt-1 + Gt – Tt_ Yt (1+gy) Yt-1 Yt Debt / GDP B t = (1+r) Bt-1 + Gt – Tt_ Yt (1+gy) Yt-1 Yt

B t = (1+i) Bt-1 + Gt – Tt_ Yt (1+) (1+gy)Yt-1 Yt Debt / GDP B t = (1+i) Bt-1 + Gt – Tt_ Yt (1+) (1+gy)Yt-1 Yt

B t = (1+r-gy) Bt-1 + Gt – Tt_ Yt Yt-1 Yt Debt / GDP B t = (1+r-gy) Bt-1 + Gt – Tt_ Yt Yt-1 Yt approximation

B t - Bt-1 = (r-gy) Bt-1 + Gt – Tt_ Yt Yt-1 Yt-1 Yt Debt / GDP = B t - Bt-1 = (r-gy) Bt-1 + Gt – Tt_ Yt Yt-1 Yt-1 Yt

Growth adjusted real interests on debt (r-gy) Bt-1 = Growth adjusted real interests Yt-1 on debt r and g have opposite effects on Bt/Yt

Debt / GDP If g > r with G=T Debt/GDP decrease Se g < r with G=T Debt/GDP increases GDP growth is a way to reduce Debt/GDP

Debt/GDP in Italy 1861-2007

Debt/GDP in Italy 46-14

Primary Surplus 1988-2014

Public Finance Strategies Balanced Budget. Balanced Budget over the Business Cycle. Surplus in growth years, deficit in recessions. Balance in growth years, deficit in recessions. EU Fiscal Compact Sales of Public Assets (privatizations) Monetary Finance. Financial Repression (capital controls and portfolio constraints) Nominal GDP growth > Debt Growth (national money).

Fiscal Compact Maximum deficit 0,5% of GDP Every year: Bt/Yt – Bt-1/Yt-1 = ( Bt-1/Yt-1 – 60 ) / 20

Recommended Reading http://www.imf.org/external/pubs/ft/weo/2012/02/pdf/c3.pdf