Budget Deficits in the Short run and in the long run Gene H Chang University of Toledo Econ 1150

Government budget deficit  Government budget deficit: BDF= G-TBDF= G-T  the government’s expenditures exceed its receipts within a fiscal year  It is a concept of flow

Deficit and debt  National Debt  the government’s total indebtedness at a particular moment  Debt is the sum of the previous deficits.  It is a concept of stock

U.S. NATIONAL DEBT CLOCK  The Outstanding Public Debt as of Oct. 12, 2011 is: 14,800,000,000,000  It is about 95% of the U.S. GDP  The estimated population of the United States is 311,000,000 so each citizen's share of this debt is $47,731.

Public Debt to GDP ratio, 2010 Debt to GDP ratio (CIA) (IMF) Japan Italy Belgium Singapore U.S France Canada Spain Nigeria

Difference between public debt and external debt  Public debt: government’s liability including domestic and foreign ones  External debt: foreign currency liability  U.S. external debt = U.S. debt owned by foreign countries - dollar liability = ?

Debt change during …

Does the U.S. have too much spending or too much tax? 2010 Tax burden % of GDP (all levels) Government expenditure % of GDP France Sweden U.K Germany Norway Canada U.S Japan Australia

Debt and deficits  The National Debt has continued to increase an average of $4.19 billion per day since September 28, 2007  Since 2005, the ceiling has been broken and lifted again and again  Now congress Sets New Federal Debt Limit: $15 Trillion?

 Not always. Attempts to achieve balance during a recession or an inflationary episode would destabilize the economy.Attempts to achieve balance during a recession or an inflationary episode would destabilize the economy. Should the Budget be Balanced? The Short Run

Should the budget be balanced?  To balance the budget in the recession would deepen and prolong the recession  In recession, tax revenue is lower because GDP is lower.  Then, to balance to budget, the government has to cut the spending  Will prolong the recession

Should the budget be balanced?  To balance the budget in the full employment state would accelerate inflation  When economy is overheating, the tax revenue is high  Then, if balance the budget, the government has to spend more  Accelerate inflation

Should the budget be balanced?  Balance the budget not in the short run, but in the long run  On average in the long run, the budget is roughly balanced

Summary  In the short run: depends on if the deficit will help the objectives of full employment and stable price.  In the long run: promote or impede economic growth.

Should the budget be balanced?  What is the current situation  Our real concern now is: structural deficits, and the ratio of deficit to GDP is growing  What implications of the current deficits and debt are?

 More deficits produce higher real interest rates and therefore lower investment, slowing economic growth.  More restrictive fiscal policy should reduce real interest rates and hence increase investment and spur economic growth. Surpluses and Deficits: The Long Run

Growth and Investment in 24 Countries Copyright © 2003 South-Western/Thomson Learning. All rights reserved Japan Norway Portugal Finland Austria Luxembourg Italy Spain Iceland Ireland Canada Greece Germany France Australia Switzerland New Zealand Netherlands Sweden Denmark U.S. Turkey Belgium U.K Average Investment as Percent of GDP, 1970–1990 Average Annual Growth Rate of per Capita Real GDP, 1970– %

Can monetary policy help the deficits?  The Policy Mix? Under expansionary fiscal policy, if the Fed does not want interest rates to riseUnder expansionary fiscal policy, if the Fed does not want interest rates to rise It can engage in expansionary open- market operationsIt can engage in expansionary open- market operations purchase more government debt.purchase more government debt.

Budget Deficits and Inflation  When Fed OMO buy bonds, that is, purchase more government debt.  The money supply will then increase.  The portion of the deficit purchased by the Fed has been monetized.  It is very inflationary

Monetization and Interest Rates Copyright © 2003 South-Western/Thomson Learning. All rights reserved. M Supply 0 M s0 M Demand D 0 Interest Rate Expansionary Fed policy Quantity of Money MS 1 Ms 1 M d D 1 C B A

Monetized Deficit Spending Copyright © 2003 South-Western/Thomson Learning. All rights reserved. Real GDP Expansionary monetary policy Price Level Expansionary fiscal policy D 0 D 0 D 1 D 1 D 2 D 2 S S A B C

The true burden of the debt How large is our national debt?  $7.7 trillion (2005),  But quickly added to $8.6 in a year.  More than a half of GDP. Around $5 trillion owned by public.  It is a rapid growth

The U.S. National Debt Relative to GDP, Copyright © 2003 South-Western/Thomson Learning. All rights reserved Budget Agreement 1981–1982 Recession 1981–1984 Tax cuts 1974–1975 Recession World War II Great Depression World War I Year Ratio of Public Debt to Gross Domestic Product 0.33

The true burden of the debt Will the Federal government go bankrupt?  Not in the legal sense. The Federal government has a privilege to print money to pay the debt.  there this can cause inflation and impede growth.

The true burden of the debt  About 30% and more are owned by local governments.  If all debts are owned by the U.S. citizens, then the U.S. debt repayment will be transfer payments among the Americans if the debt is owned by Americans,

The true burden of the debt  But an increasing portion of the debt is owned by foreigners  The new concern is that an increasing share of debts are owned by foreigners.  Then our children need pay goods or assets to foreigners when they demand to redeem the bonds in their hands.

The true burden of the debt  Which means that the future generations need to produce more than they consume, in order to give the goods and services to those foreigners who have the U.S. bonds in hands.  IOU matures

ECONOMY Struggling U.S. dollar triggers currency concerns Long-term threat of 'trade chaos' cited BARRIE MCKENNA WASHINGTON -- Renewed fears that the Chinese central bank may be poised to start liquidating its $1-trillion stash of U.S. dollars briefly drove the greenback to a 20-month low against the euro and a two-year low against the British pound in trading yesterday. The euro surged to $ (U.S.) against the greenback and the pound to $1.9469, before losing ground by day's end. The loonie and the yen have also gained on the U.S. dollar in recent days. The sudden weakness of the U.S. dollar began late last week, soon after Chinese officials suggested that holding a lot of dollars might be a losing investment strategy. Investors read that as a signal that the massive trade and financial imbalances between Asia and the U.S. may be about to unwind. The chief worry is that if China's central bank -- the largest foreign holder of U.S. dollars -- begins to unload its reserves, the dollar will plunge. With China's yuan effectively pegged to the dollar, other leading currencies would move higher after the realignment.

To judge  To judge if the short run borrowing or increase in debt is justified or not, depends on if it can promote economic growth or not.

The true burden of the debt What is the burden of deficits?  Inflation  Nominal interest rate will go up.  Crowding-out effect that adversely affect the long-run growth

The true burden of the debt Key to answer the question:  How would the policy affect the long term economic growth.  Deficits may promote or impede economic growth

The true burden of the debt Growth and productivity  How can we repay our debt owned by foreigners?  Investing in human capital and raising productivity