1 Chapter 23 Federal Deficits and the National Debt Key Concepts Key Concepts Summary Practice Quiz Internet Exercises Internet Exercises ©2002 South-Western College Publishing

2 What is the purpose of this chapter? To take a closer look at the actual budgetary process that creates and finances our national debt

3 What are the four stages of the budget process? Agency budget proposals Presidential budget submission First budget resolution Second budget resolution

4 What is the federal fiscal year? October 1 through September 30

5 What is the federal deficit? How much money the government borrows in any given fiscal year

6 What is the national debt? The total amount owed by the federal government to owners of government securities

7 How does the U.S. Treasury borrow money? By selling Treasury bills, notes, and bonds, promising to make specified interest payments and to repay the loaned funds on a given date

8 $200 Year Federal Expenditures and Tax Revenues Billions of dollars $400 $1,600 $600 $800 $1,000 $1,200 $1, Expenditures Revenues 0005

9 17 Year Percentage of GDP Federal Expenditures, Revenues, and Deficits as a Percentage of GDP Federal Deficit

10 $-350 $ $-250 $-200 $-150 $-100 $-50 Deficit Federal Budget Surpluses and Deficits Billions of dollars Surplus $

11 What has been done to curb the national debt? Tax increase Spending caps Line-item veto Debt ceiling

12 What happened to taxes in 1993? Raised the highest marginal tax rate from 31% to 36% Increased tax on gasoline by 4.3 cents per gallon

13 What happened to spending in 1993? Reduced military spending and and cut some entitlements, including Medicare, Medicaid, and food stamps

14 What is a debt ceiling? The legislated legal limit on the national debt

15 What usually happens when the debt pushes against the ceiling? Congress raises the ceiling to accommodate the budget deficit

Year $1 $2 $3 $4 $5 $6 National debt The National Debt 00 Trillions of dollars

17 05 Year National debt/GDP Percentage of GDP The National Debt as a Percentage of GDP

18 What is the internal national debt? The portion of the national debt owed to a nation’s own citizens

19 What is the external national debt? The portion of the national debt owed to foreign citizens

% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 4.0% Federal Net Interest as a Percentage of GDP Year Percentage of GDP

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22 What is the crowding-out effect? When federal government borrowing increases interest rates, the result is lower consumption and investments

23 Can the government go bankrupt? Yes, it’s possible No, the debt need never be paid off

24 Are we passing the debt burden to our children? Yes, especially if it continues to increase No, not as long as the debt is internally owned

25 Does government borrowing crowd out private-sector spending? Yes, the more the government borrows the less loanable funds for everyone else No, especially if it occurs during economic downturns

AD 1 AS AD` AD 2 E2E2 E1E1 E` 2 full employment Complete (AD 1 ), Partial (AD` 2 ), and Zero (AD 2 ) Crowding Out

27 Key Concepts

28 Key Concepts What is the federal deficit? What is the national debt? How does the U.S. Treasury borrow money? What has been done to curb the national debt? What is a debt ceiling? What is the internal national debt? What is the external national debt? What is the crowding-out effect? Can the government go bankrupt? Are we passing the debt burden to our children? Does government borrowing crowd out private- sector spending?Does government borrowing crowd out private- sector spending?

29 Summary

30 The national debt is the dollar amount that the federal government owes holders of government securities. It is the cumulative sum of past deficits.

31 The U.S. Treasury issues government securities to finance the deficits. The debt has more than tripled since The debt ceiling is a method to restrict the national debt.

Year $1 $2 $3 $4 $5 $6 National debt The National Debt 00 Trillions of dollars

33 Internal national debt is the percentage of the national debt a nation owes to its own citizens.

34 External debt is a burden because it is the portion of the national debt a nation owes to foreigners.

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36 The crowding-out effect is a burden of the national debt that occurs when the government borrows to finance its deficit, causing the interest rate to rise. As the interest rate rises, consumption and business investment fall.

37 Can Uncle Sam go bankrupt? The U.S. government will not go bankrupt because it never has to pay off its debt. When government securities mature, the U.S. Treasury can refinance or roll over the debt by issuing new securities.

38 Are we passing the debt burden to our children? There are two differing opinions on this question.

39 Are we passing the debt burden to our children? No One side of this argument is that the debt is mostly internal, so financing a deficit only involves exchanging old bonds for new bonds among U.S. citizens.

40 Are we passing the debt burden to our children? Yes The sizeable external debt transfers purchasing power to foreigners.

41 Does government borrowing crowd out private sector spending? Keynesian theory assumes zero crowding out when the federal government increases spending in order to shift the aggregate demand curve rightward.

42 Chapter 23 Quiz ©2002 South-Western College Publishing

43 1. During the late 1990’s, federal government budget deficits a. were completely removed. b. dropped significantly from a high of $300 billion. c. remained fairly stable at about $150 billion per year. d. exceeded $200 billion in each year. B.

44 $-350 $ $-250 $-200 $-150 $-100 $-50 Deficit Federal Budget Surpluses and Deficits Billions of dollars Surplus $

45 2. The federal government finances the federal deficit by a. taxing businesses and households. b. selling Treasury securities. c. printing more money. d. reducing its purchases of goods and services. B. The U.S. Treasury borrows by selling Treasury bill (T-bills), notes, and bonds promising to make specified interest and repay the loan on a given date.

46 3. In 1998, the national debt was approximately a. $60 billion. b. $600 billion. c. $6 trillion. d. $5 trillion. D.

Year $1 $2 $3 $4 $5 $6 National debt The National Debt 00 Trillions of dollars

48 4. The national debt a. doubled between 1950 and 1980, and by 1990, it was over four times its size in b. doubled between 1950 and 1980 and doubled again between 1980 and c. stayed at approximately the same amount between 1950 and 1980 and doubled between 1980 and d. was four times larger in 1980 than it was in 1950 and then doubled between 1975 and A.

Year $1 $2 $3 $4 $5 $6 National debt The National Debt 00 Trillions of dollars

50 5. Which of the following countries has the smallest national debt as a percentage of GDP? a. Italy. b. Canada. c. United Kingdom. d. Japan. e. France. D.

51 6. Which of the following is false? a. The national debt’s size decreased steadily after World War II until 1980 and then increased sharply each year. b. The national debt increases in size whenever the federal government has a budget surplus. c. The size of the national debt currently is about the same size as it was during World War II. d. All of the above are false. D.

52 7. In 1998, how much of the U.S. national debt was owed to foreigners? a. About 2.5%. b. About 17%. c. About 31%. d. About 59%. B.

53 8. Which of the following owns a proportion of the national debt? a. Federal, state, and local governments. b. Private U.S. citizens. c. Banks. d. Foreigners. e. All of the above. E. Treasury bills are widely held throughout the public and private sectors both domestically and overseas.

54 9. The portion of the U.S. national debt held by foreigners a. represents a burden because it transfers purchasing power from U.S. taxpayers to other countries. b. is an accounting entry that represents no real burden. c. decreased as a proportion of the total debt during the 1980’s. d. has been constant for many decades. A. Approximately 17 percent of total U.S. debt is external debt.

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Which of the following statements about crowding out is true? a. It is caused by a budget surplus. b. It is not caused by a budget surplus. c. It cannot completely offset the multiplier effect of deficit government spending. d. It affects interest rates and, in turn, consumption and investment spending. D. The crowding-out effect is a reduction in private spending caused by federal deficits financed by U.S. Treasury borrowing.

Which of the following statements about crowding out is true? a. It can completely offset the multiplier. b. It is caused by a budget deficit. c. It is not caused by a budget surplus. d. All of the above are true. D. If crowding out occurs, reduced private spending offsets the multiplier effect of increased government spending. The debt is a summation of each years deficits and therefore effects consumption and investments. No crowding out occurs with budget surpluses because the government is not competing with consumers and investors for available funds.

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