Long-Run Implications of Fiscal Policy Chapter 12-4

Defining Surpluses and Debt A surplus is an excess of revenues over payments. A deficit is a shortfall of revenues over payments.

The Definition of Debt and Assets Debt is accumulated deficits minus accumulated surpluses. Deficits and surpluses are flow concepts. Debt is a stock concept.

Long-Run Implications  U.S. government budget accounting is calculated on the basis of fiscal years.  Persistent budget deficits have long- run consequences because they lead to an increase in public debt.

A String of Deficits

Always in Debt : Debt Free! – The U.S. was completely out of debt by The Mexican-American War ( ) caused a four-fold increase in the debt

Debt as a Percentage of GDP 100%

Problems of Rising Debt This can be a problem for two reasons: 1. Public debt may crowd out investment spending, which reduces long-run economic growth. 2. And in extreme cases, rising debt may lead to government default, resulting in economic and financial turmoil.

Deficits and Debt in Practice A widely used measure of fiscal health is the debt–GDP ratio. This number can remain stable or fall even in the face of moderate budget deficits if GDP rises over time. Debt relative to GDP provide a measure of a country’s ability to pay off or service its debt.

Government Debt as a Percentage of GDP

U.S. Federal Deficit since 1939 The debt–GDP ratio is government debt as a percentage of GDP.

The Federal Debt–GDP Ratio Since 1939

Japanese Deficits and Debt

Debt/GDP fall GDP growsfasterdebt–GDP ratio can fall, even when debt is rising, as long as GDP grows faster than debt risedebt grows fasterdebt–GDP ratio will rise if debt grows faster than GDP

The Debt Burden Most of the decrease in the U.S. debt-to- GDP ratio occurred through growth in GDP. When GDP grows, the government can reasonably handle more debt.

Who do we owe? Public DebtPublic Debt is government debt held by individual and institutions outside the government. Big part of the Government debt is owned by the Government! –It owes money to itself?

Debt Federal Reserve (9%) © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Foreign individuals and firms (25%) U.S. individuals and firms (24%) U.S. government agencies (42%)

Implicit Liabilities Implicit liabilities are spending promises made by governments that are effectively a debt despite the fact that they are not included in the usual debt statistics.

Gross Debt Gross Debt = Public Debt + implicit liabilities A more accurate indicator of Government Fiscal health

The Implicit Liabilities of the U.S. Government

Can The Government Go Bankrupt? A complicated question Dr. Krugman seems to worry about it but…

Difference Between Individual and Government Debt Government debt is different from an individual’s debt for the following reasons: –Government debt is ongoing – it does not die. –Government can print money to pay off its debt – individuals can’t. This usually leads to inflation Your text talks about this on p310 but moves on fast

Will the debt make us poorer? Liability is an Asset Do you remember that every Liability is an Asset to someone else?

Difference Between Individual and Government Debt*** Paying interest on the internal debt involves a redistribution among citizens of the country. notIt does not involves a net reduction in income of the average citizen.

External debt – government debt owed to individuals in foreign countries. Difference Between Individual and Government Debt** External debt (Debt owed to foreigners) is more like an individual’s debt.

So can the Gov. go broke? That is our question for the one minute paper!That is our question for the one minute paper!