1. Debts and Deficits Lecture 17

2. Debts and Deficits
Deficits (or Surpluses) are the difference between government spending (G) and government revenue (T) in a year
The National Debt is the sum of all past deficits and surpluses

3. Effects of the Debt Crowding out reduces private investment
Debt finance of public investment or consumption?
Longer term redistributions
From tax payers to bondholders
From tax payers to foreigners (out of our circular flow
of income and into theirs)

4. It’s a Fertile Ground for Misinformation and Paranoia
People hate personal debt
Mistaken analogies between household debt and national debt
Nowhere is hysteria more evident than in graphs of the facts

8. Use “Emergency” Colors

9. Scale it so it looks
like a rocket taking off

10. Another

11. Use the word “DEATH”

12. Actually, That Last Slide Had Some Good Info
The importance of looking at debt as a percent of GDP
The long historical view and debt peaks in the past
We never did “pay down” the highest debt/GDP ratio of all
You can reduce debt/GDP two ways!

13. The basic debt dynamic equation
Debt = This year’s deficit plus the sum of ALL past deficits and surpluses
Put another way, Debt this year equals debt last year plus interest on that debt plus/minus any new borrowing/repayment this year (the deficit or surplus)

14. When is Debt/GDP Growing?
Debt/GDP is the important variable
A million dollar debt is a lot to me but not to Bill Gates
Debt relative to GDP can go down by
Paying down the debt
Increasing GDP faster than the debt

15. When is Debt/GDP Growing?
So if GDP growth is faster than debt growth, Debt/GDP goes down
If GDP growth rate is the same as the interest rate then debt/GDP remains constant

16. Some Important Implications
One important way to reduce Debt/GDP is to invest in capital so GDP grows faster
Trying to reduce Debt/GDP by cutting spending (and therefore the deficit) has a built-in problem – When you cut spending the economy slows down and this tends to increase the deficit again.

17. Government Deficit Issues
Deficit Targeting
Gramm-Rudman-Hollings Act Passed by the U.S. Congress and signed by President Reagan in 1986, this law set out to reduce the federal deficit by $36 billion per year, with a deficit of zero slated for 1991.
 FIGURE Deficit Reduction Targets under Gramm-Rudman-Hollings
The GRH legislation, passed in 1986, set out to lower the federal deficit by $36 billion per year.
If the plan had worked, a zero deficit would have been achieved by 1991.

18. Government Deficit Issues
Deficit Targeting
Deficit targeting has undesirable macroeconomic consequences.
It requires cuts in spending or increases in taxes at times when the economy is already experiencing problems.
Locking in spending cuts or tax increases during periods of negative demand shocks is not a good way to manage the economy.
Moving forward, policy makers around the globe will have to devise other methods to control growing structural deficits.

19. Government Deficit Issues
Deficit Targeting
automatic stabilizers Revenue and expenditure items in the federal budget that automatically change with the economy in such a way as to stabilize GDP.
automatic destabilizers Revenue and expenditure items in the federal budget that automatically change with the economy in such a way as to destabilize GDP.

20. Government Deficit Issues
 FIGURE Deficit Targeting as an Automatic Destabilizer
Deficit Targeting
Deficit targeting changes the way the economy responds to negative demand shocks because it does not allow the deficit to increase.
The result is a smaller deficit but a larger decline in income than would have otherwise occurred.

23. Who Do We Owe it To?

24. The Importance of the Currency You Borrow In
“If we keep running deficits we will turn into Greece, Greece, GREECE!!!!
Greece’s national debt is denominated in Euros which means they do NOT control their own monetary policy
USA’s national debt is denominated in dollars

25. What Do Greece and the US Have to Do to Pay Off Debt?
Greece has to run a trade surplus and/or engineer a deep enough depression to create a surplus
USA has two options
First is don’t pay off the the debt until later (if ever)
Second is to monetize the debt via the Federal Reserve

26. Consequences of Debt Monetization
In a liquidity trap, not very many consequences. Interest Rates and Prices stuck
Suppose prices DO rise. What then?
Inflation (but we have been trying to get higher inflation for years now)
Depreciation of our currency