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The National Debt. Chapter #20. Introduction. There is limit to how large a national debt a country can support ( if too large, econ could be in fragile state where shocks can push the entire econ into a crisis) Much of discussion on national debt is political discussion about G & T
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The National Debt Chapter #20
Introduction • There is limit to how large a national debt a country can support (if too large, econ could be in fragile state where shocks can push the entire econ into a crisis) • Much of discussion on national debt is political discussion about G & T • High debt levels were central to European econ crisis after Great Recession • The debt is the total amount the government owes as a consequence of past borrowing in years that government spending exceeded tax revenues • Size of the debt relative to the size of the economy is important measure of debt (debt to GDP or debt/Y)
Mechanics of the Debt National debt is accumulation of unpaid past bills. Debt is last year’s debt & current budget deficit: DEBTt+1 = DEBTt + BDt+1 BD = primary deficit + interest payments (Primary or non-interest deficit is under current government control, but interest payments are legacy) DEBTt+1 = DEBTt + primary deficitt + i*DEBTt Funds devoted to interest payments cannot be spend on government programsInterest payments relative to G increased in 1980s & 90s for both increase in debt & i.Although debt grew substantially in GreatRecession (07-09) low interest % kept payments down. Interest payments relative to Y around 1.5%since WWII but 3% in 80s & 90s for high i.
Measuring the Deficit • Deficit is current revenues minus current outlays no accounting for depreciation or capital acquisition (Grand Coulee Dam) • There is no accounting for assets or unfunded liabilities • Debt-to-GDP ratio measures the size of the debt relative to the size of the economy (debt has been rising over time, but so has the economy) • A useful mathematical view of the debt is the growth rate4 of the debt-to-GDP ratio: %∆(Debt/Y) = %∆Debt - %∆Y • If the economy is stagnant for a long period, even small increase in the debt can result in large relative changes • With a growing economy, modest increase in the debt results in a declining debt value relative to GDP
Who Owns the Debt • National debt ($16.4T > GDP $15.7T in Jan 2013) owned by: • U.S. public • International investors • Government (liability to one but offsetting asset to another part) • Fed - Sum of 1 & 2 ($11.5T in Jan 2013) referred to as “debt held by the public”. - 16% owned by Fed represents open market purchases over the years (effectively no interest payments since most of the interest that Treasury pays to Fed, Fed returns to Treasury). - Interest paid to international Investors leaves US & cannotbe used by Americans. - China owns about 13%,followed Japan w/ 9% (combination of prolongeddeficit & low US savings%,& safe place to invest)
When Is The Debt a Crisis? • Two major consequences of large debt-to-GDP ratio: • Money spent on interest payments cannot be used for desired programs (G) • Regret – need to increase current taxes (intergenerational use of funds & voters) • While nations do not have credit limit (as individuals do) markets will stop lending if repayment becomes questionable • What happens to nation that lived beyond means & can’t borrow any more?If loans used for payroll & pensions, payments will be cut. State employees & businesses run out of money. Tempted to default on sovereign debt. • Related is the size of the government (US G/Y: 23% in 1960, 35% in 2012) • Debate (political more than economic): how should society efficiently use scares resources vs education, infrastructure, transfers • After Great Recession unsustainable national debt combined with recession in many countries. ↓G &/or ↑T solve the 1st but aggravate the 2nd problem. • Cost of Fed’s solving the 2nd problem was worsening of the 1st problem. • Members of EU do not have independent monetary policy & often forced to ↓G &/or ↑T in order to maintain agreed “ratios”. • Low debt-to-GDP allows use of expansionary fiscal policy when monetary policy cannot be used.
Debt in the International Arena • Causes of the European “debt crisis” • A number of countries had run up very high debt‐to‐GDP ratios. • Banking systems in several countries was greatly over extended following fin crisis that had started the Great Recession. Repayment of loans & investments made before the crisis became uncertain. • Markets seemed to have anticipated that national debts were somewhat backed by implicit promises from ECB & larger, stronger economies in Europe, notably Germany. • Eurozone countries (EU less UK & Scandinavia) don’t have independent monetary policy. Devalued drachma would lower payments on drachma loans & stimulate NX. To compete Greece forced to lower wages – less attractive than pricier foreign goods.
