Debt

DEFICIT VS. DEBT FLOW VS. STOCK Chapter 15 part 3

Defining Debt and Assets Debt is accumulated deficits minus accumulated surpluses • Debt is a stock, defined at a point in time

DEFICITS AND SURPLUSES ARE FLOW CONCEPTS, DEFINED FOR A PERIOD OF TIME

Debt is a stock, defined at a point in time

Debt Debt is accumulated deficits minus accumulated surpluses • Debt is a stock, defined at a point in time

Debt = Accumulated Deficits + Accumulated Surpluses

• Deficit Increases the Debt

• Surpluses Reduce the Debt

• If a country has more surpluses than deficits, the accumulated surpluses minus accumulated deficits are a part of its assets

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 longrun consequences because they lead to an increase in public debt.

A String of Deficits

Budget Surpluses

Budget Deficits

1970 19721974 19761978 1980 1982 19841986 1988 19901992 1994 1996 1998 2000 2002

The U.S. Government Has Always Been in Debt Except • 1835-36: Debt Free! – The U.S. was completely out of debt by 1835. • The Mexican-American War (1846-48) caused a four-fold increase in the debt

The Public Debt • Differentiating between the Deficit and the Debt – The deficit occurs when federal government spending is greater than tax revenue – The debt is the cumulative total of all the federal budget deficits less any surpluses • Suppose that our deficit declined one year from $200 billion to $150 billion • The national debt would still go up by $150 billion • So every year that we have a deficit – even a declining one – the national debt will go up

Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

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The Public Debt National Debt, 1975-2000 6

5

4

3

2

1

0 1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

Economic Report of the President, 2000 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

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How it works? • The U.S. Treasury must sell new bonds to pay for a deficit and refinance previously issued bonds as they come due

Debt Management  Debt, as a summary measure of a nation’s financial situation, needs to be judged in relation to a nation’s assets  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 society better off

Debt Foreign individuals and firms (25%)

U.S. individuals and firms (24%)

U.S. government agencies (42%)

Federal Reserve (9%) © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

Ownership of the Debt Other U.S. government trust funds, 12%

Social Security trust fund, 18%

Federal Reserve, 11%

In 2012

Difference Between Individual and Government Debt 1. The government lives forever; people don’t

2. The government can print money to pay its debt; people can’t 3. Government owes much of its debt to itself (to its own citizens) • Internal debt is government debt owed to other governmental agencies or to its own citizens

• External debt is government debt owed to individuals in foreign countries

Difference Between Individual and Government Debt

1

• The government lives forever; people don’t

2

• The government can print money to pay its debt; people can’t

3

• Government owes much of its debt to itself (to its own citizens)

•Internal debt is government debt owed to other governmental agencies or to its own citizens •External debt is government debt owed to individuals in foreign countries

U.S. Budget Deficits as Percentage of GDP Deficits and debt relative to Deficits as percentage of GDP 10

GDP provide measures of a country’s ability to pay off a deficit and service its debt

0 -10

-20 -30

1900

1920

1940

1960

1980

2000

2020

U.S. Debt as Percentage of GDP Debt as Percentage of GDP 100

75

50

25

1800

1840

1880

1920

1960

2000

‘20

Ignore the Absolute Figure when it comes to Deficit and Debt!

Measure Deficit and Debt as a Percentage of GDP!

Debt / GDP = Debt to GDP Ratio

READ THE SECTION ON THE DEBT BURDEN

U.S. Debt Compared to Foreign Debt

82% 82% 80% 68% 52%

The U.S. debt does not appear so large when compared to the debts of some other countries in the early 2000s

42% 37% 23%

Debt as a Percentage of GDP

Federal Interest Payments Relative to GDP Interest payments as percentage of GDP 3.5

Interest rates fell and surpluses reduced the total debt

High interest rates and large increases in debt

3.0 2.5 2.0 1.5 1.0 0.5 1945

1955

1965

1975

1985

1995

2005

2015

Chapter Summary  A deficit is a shortfall of revenues under payments  A surplus is the excess of revenues over payments  Debt is accumulated deficits minus accumulated surpluses

 Deficits and surpluses are summary measures of a budget  A cyclical deficit is that part of the deficit that exists because the economy is below or above potential output

 A structural deficit is that part of a budget deficit that would exist even if the economy were at its potential level of output

Chapter Summary  A real deficit is a nominal deficit adjusted for the effect of inflation  A country’s debt must be judged in relation to its assets

 Government debt and individual debt differ  Deficits, surpluses, and debt should be viewed relative to GDP because this ratio better measures the government’s ability to handle the deficit and pay off the debt  Since 2008, the U.S. has run significant deficits and the debt-toGDP ratio has risen to over 100 percent