macroeconomics ch 12

8/10/2019 Macroeconomics Ch 12

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Chapter 12: Surpluses, Deficits, and Debt


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Keywords: Surpluses and Deficits

A budget surplus is an excess of government revenue over

government spending (revenue > spending).

A budget deficit is a shortfall of government revenue under

government spending (spending > revenue).

Both are flow concepts [they are defined relative to a

period of time (e.g., year 2014)].


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D e b t V s D e f i c i t

While the National Debt is a RUNNING TOTAL of all deficits minus all

surpluses, the Deficitis equal to the increases in debt from one year

to the next.

The United States has borrowed more that is has saved during its 239

years (since George Washington), so the United States owes its

citizens and foreign governments in 13 Dec 2014 about:

The US National Debt has continued to increase an average of

$2.41 Billion PER DAY since September 30, 2012! ! !


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Introduction

In the short-run framework:

The view of surpluses and deficits depends on the state of

the economy relative to its possible income. If the economy

is running below its potential output, deficits are good and

surpluses are bad.

Deficits increase expenditures, increasing output

by a multiple of that amount of expenditures.


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Introduction (con)

In the long-run framework:

Surpluses are good because they provide additional

saving for an economy.

Deficits are bad because they reduce saving,

growth, and income.


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Introduction (con)

Combining the long-and short-run frameworks

gives the following policy:

Whenever possible, run surpluses, or at least a

balanced budget, to help stimulate long-term

growth. This is especially true when the economy is

booming when it is above its level of potential

income.

The argument for surpluses is weakened, and likely

reversed (a deficit is favored), when the economy

falls into a recession.


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Introduction (con)

Both short- and long-term economic

frameworks would recommend cutting the

national debt.

Instead of doing so, various governments

have looked at ways to spend the

surpluses, either by cutting taxes or byincreasing spending.


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Financing the Deficit

Deficits must be financed.

The U.S. finances its deficits by issuing treasury bonds, which

are IOUs (Investor Owned Utilities) from the federal

government. These bonds are purchased by U.S. companies

and households, and foreign governments, companies, and

households. Treasury bonds are a very safe investment, which

makes them very popular.


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Financing the Deficit (con)

Since the central bank's IOUs (Investor Owned

Utilities) are money, the deficit can also be paid by

printing money.

Potentially, the central bank has an

unlimited source of funds.


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Financing the Deficit (con)

However, printing too much money would

trigger inflation which can have a negative

effect on the economy.


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Arbitrariness in Defining Surpluses and Deficits

Defining surpluses and deficits can be arbitrary.

Whether or not a nation has a deficit depends on what is

included as a revenue and what is included as an

expenditure (e.g., The Retirement Income system which is

based on promises to pay). The way these programs is accounted for plays an

important role in whether there is a budget deficit or

surplus.

This accounting issue is central to the debate about

whether we should be concerned about a deficit.


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Nominal and Real Surpluses and Deficits

Another distinction that economists make when discussing

the budget deficit and surplus picture is the real/nominal

distinction:

Nominal deficit The deficit determined by looking at the

difference between expenditure and revenue. It's what

most people think of when they think of the budget deficit;

it's the value that is generally reported.

Real deficit is the nominal deficit adjusted for inflation.


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Nominal and Real Surpluses and Def ic i ts (con)

To understand this distinction, it is important to recognize that

inflation wipes out debt (accumulated deficits less accumulated

surpluses).

For example, if inflation is 4 percent per year, the real value of all assets

denominated in dollars is declining by 4 percent each year. If you had

$100, that $100 will be worth 4 percent less at the end of the year

the equivalent of $96 without inflation. By the same reasoning, when

there's 4 percent inflation, the value of the debt is declining 4 percent

each year. If a country has a debt of $2 trillion, 4 percent inflation will

eliminate $80 billion of the real value of the debt each year.


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Nominal and Real Surpluses and Def ic i ts (con)

The larger the debt and the larger the inflation, the more debt

will be eliminated by inflation.

For example, with 10 percent inflation and a $2 trillion debt, $200 billion

of the debt will be eliminated by inflation each year. With 10 percent

inflation and a $5 trillion debt, $500 billion of the debt would be

eliminated.


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Nomina l and Rea l Surp luses and Def ic i t s (con)

If inflation is wiping out debt, and the deficit is

equal to the increases in debt from one year

to the next, inflation also affects the deficit.


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We can calculate the real deficit by subtracting the decrease

in the value of the government's total outstanding debts

due to inflation. Specifically:

Real Deficit = Nominal Deficit (Inflation X Total Debt)

For example, Say that the nominal deficit is $280 billion,

inflation is 4 percent, and total debt is $3 trillion.

Substituting into the formula gives us a real deficit of $160

billion [$280 billion (0.04 $3 trillion) = $280 billion

$120 billion = $160 billion].


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This insight into debt is directly relevant to the budget

situation in the United States.

For example, back in 1990, the nominal U.S. deficit was $221

billion, while the real deficit was $79 billion; in 2006 the

nominal deficit was $248 billion; there was 2.9 percent

inflation and a total debt of about $8.5 Trillion. That means

the real deficit was only $1 billion.



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The lowering of the real deficit by inflation is

not costless to the government:

Persistent inflation becomes built into

expectations and causes higher interest

rates.


i l d fi i


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Passive Surpluses and Deficits

A passive (also known as cyclical) surplus or deficit is the part of the

deficit or surplus that exists because the economy is operating belowor above its potential level of output.

A passive deficit can be attributed to the weak economy. A recession

drives down government revenue because many workers andbusinesses are no longer earning as much taxable income. At the

same time, government spending rises because more people need

assistance through programs such as unemployment benefits and

food stamps. The result is a temporary, or cyclical, increase in the

deficit. Once the economy recovers, tax revenue and government

spending on assistance programs should return to normal levels.


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Structural Vs Passive Deficits

Structural deficits are of greater concern than passive

(or cyclical) deficits. Economic growth can eliminate

passive deficits but not structural.

Actual Deficit = Structural deficit + Passive deficit


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Structural Vs Passive Deficits (con)

The United States currently (2014) faces both acyclical and a structural deficit. The cyclical

deficit is caused by severe recession from which

the country is still recovering. The structural

deficit reflects a chronic mismatch between

government revenue and spending that undercurrent policies will dramatically worsen as

healthcare costs rise and the population ages.


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T h e D e f i n i t i o n o f D e b t a n d A s s e t s

Debt is accumulated deficits minus accumulated surpluses.

Whereas deficits and surpluses are flow measures (they are defined for a

period of time), debt is a stock measure (it is defined at a point in time).

For example, say you've spent $30,000 a year for 10 years and have had annual

income of $20,000 for 10 years. So you've had a deficit of $10,000 per year

(a period of time) a flow. At the end of 10 years (a point in time), you will

have accumulated a debt of $100,000a stock. (Spending more than you

have in income means that you need to borrow the extra $10,000 per yearfrom someone, so in later years much of your expenditure will be for

interest on your previous debt).


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The Need to Judge Debt Relative to Assets

Debt is a summary measure of a nationsfinancial situation.

Unlike a deficit, which is the difference between outflows and

inflows, and hence provides both sides of the ledger (the principal

book for recording and totalling economic transactions measured in

terms of a monetary unit of account by account type, with debits and

credits in separate columns and a beginning monetary balance and

ending monetary balance for each account), debt by itself is only half

of a picture. The other half of the picture is assets.


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For a government, assets include:

Its skilled work force.

Natural resources (crude oil, gas ..).

Its factories (civil and military).

Its housing stock.

Holdings of foreign assets.

The federal buildings and land it owns.

Financial assets held by the government (cash, reserves,

and loans). A portion of the assets of the people in the country, since

government gets a portion of all earnings of those assets as

tax revenue.


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To get an idea of why the addition of assets is

necessary to complete the debt picture, considertwo governments:

one has debt of $3 trillion and assets of $50 trillion;the other has only $1 trillion in debt but only $1trillion in assets. Which is in a better financialposition?

The government with the $3 trillion debt is, because

its debt is significantly exceeded by its assets. Thepoint is simple: To judge a country's debt (or aperson), we must view its debt in relation to all itsassets.


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This need to judge debt relative to assets adds an

important caution to the long-run position that

government budget deficits are bad:

When the government runs a deficit, it might be spending

on projects that increase its assets. If the assets are

valued at more than their costs, then the deficit is

making the society wealthier. Government investment

can be as productive as private investment or even

more productive.


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Subjectiveness in Defining Debt and Assets

Defining debt and assets can be subjective.

As was the case with income, revenues, and

deficits, there is no perfect answer as to howassets and debt should be valued.

Even after assets are taken into account, you

still have to be careful when deciding whether

or not to be concerned about debt.


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The total stock of gross debt can be broken down

into (1) market debt and (2) non-market debt.

Market debt includes any tradable financial asset of any

kind (e.g., banknotes, bonds, common stocks, and swaps).

Non-market debt includes federal public sector pensionliabilities and other federal liabilities (e.g., social security

and retirement pensions).


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To calculate debt, we add market debt and non-

market debt, and subtract the value of

financial assets held by the government, such

as cash, reserves, and loans.

Government Deficits and Debt The Historical Record


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Government Deficits and Debt: The Historical Record

Most economists do not look at absolute figures of deficits

and debt. They prefer the relative to GDP measurement:

debt/GDP % ratio because it better measures the

governments ability to handle the deficit and pay off the

debt.

The ability to pay off a debt depends on anations productive capacity, the asset

side of the equation.


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Debt Relative to Other Countries

Lebanon has a relatively large debt compared to

other underdeveloped economies.

There is a structural deficit in Lebanon even at

full employment, spending exceeded revenue.


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The Debt Burden

When GDP grows, the debt the government

can reasonable handle also grows.

The economy becomes richer, and,

being richer, it can handle more debt.


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The Debt Burden

If the real growth of the GDP in a country (e.g.,

Lebanon) is about X % this year.

This means that the debt of the Lebanesegovernment can grow this year at the samerate (X %) without increasing the debt/GDP

ratio.


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Interest Rates and Debt Burden

Besides the debt relative to GDP figures, economists

are concerned about the interest rate paid on the

debt because interest rates affect debt burden.

How much of a burden a given amount of debt

imposes depends on the interest rate that must be

paid on that debt.


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The interest rate determines annual debt

service.

Annual debt serv icethe interest rateon debt times the total debt.


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Ultimately, the interest payments are the

burden of the debt.

That is what people mean when theysay a deficit is burdening future

generations.


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The Modern Debate About the Surplus

The modern debate about the government

budget concerns what to do with the surplus

(e.g., in China, in Germany).


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Why Did the Surpluses Come About?

Keynesian economics made clear that deficits

could serve a positive function when the

economy was below its potential.

This view was never fully accepted by

politicians, nor by the public.


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The 1980s saw a change in the political view.

Politicians were pushing the economytoward deficits by cutting taxes, and

expanding the deficits.


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In the 1990s, the federal government realized

it increased its spending to the point it was

running a structural deficit.

Even if the economy were operating at

the potential output, the budget wouldbe in deficit.


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In response, the authorities raised

taxes, cut many social programs andredesigned existing programs.



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The surpluses of the late 1990s were brought

about by the unexpected growth of the economy

and a low and stable rate of inflation.

Interest rates stayed low, holding down

government interest payments.

Expected tax revenue also increased, and deficit

predictions moved in the opposite direction, to

surplus predictions.


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Federal Deficit and Debt Are Only Part of the Picture

States and local municipalities also run deficits by

borrowing to spend in excess of their revenues, and

thereby raise the total amount of government debt

(Federal debt+ statesdebt + localmunicipalities

debt )in the economy.

N b d l i i l d


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Net Debt: Federal, Provincial and

Local, Fig. 12-4a, p 298

0

100000

200000

300000

400000

500000

600000

700000

1977 1980 1983 1986 1989 1992 1995 1998 2001

Federal Net Debt

Provincial Net Debt

Local Net Debt


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Net Debt: Federal, Provincial and Local

-50000

-40000

-30000

-20000

-10000

0

10000

20000

1 2 3 4 5 6 7 8 9 10 11 12 13

Federal Deficit

Provincial and LocalDeficit


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A Different Type of Crowding Out

High government deficits require more and

more borrowing, reducing the capital available

to government and private enterprise.

Interests rates increase as a result, and this

means that borrowing is more expensive for

firms who wish to fund expansion by issuing

debt (such as bonds).


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A Different Type of Crowding Out

Increase in government spending increases

interest rates, and increase the value of

domestic currency.

When domestic currency gains value,

exports decrease, and imports rise.

Is the Deficit a Good Measure of the Stance of Fiscal


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Is the Deficit a Good Measure of the Stance of Fiscal

Policy?

Can we use deficit to find out if fiscal policies are

becoming more or less expansionary the

stance of fiscal policy? ?

The answer is NO. Deficit can change as a result

of a shift in an autonomous component of

demand.

Is the Deficit a Good Measure of the Stance of


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Is the Deficit a Good Measure of the Stance of

Fiscal Policy?

If autonomous spending (investment, for example)

decreased, deficit would rise because income would

fall and reduce tax revenues. This deficit increase was not a result of

expansionary fiscal policy.

A better measure of the stance of fiscal policy is

the structural deficit.

macroeconomics ch 12

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