MECH 3360 - Deficits and Debts

Economics - Lecture 6

What is a deficit? When does it occur?

A deficit is when a nations spending is greater than the revenue they receive, usually over a year.

Define national debt.

The accumulation of each years deficit.

What is a surplus? What does it reduce?

A surplus is when a nations revenue exceed the spending. A surplus will reduce debt.

Japan has a national debt to GDP ratio of approximately 238%, the highest in the world. Despite this, they are one of the leading economic powers in Asia. What does this tell us about a high national debt?

A high debt ratio doesn’t mean that the country has poor economic health, but it can sometimes result in poor investor confidence and lower capital.

What worries exist when the government runs a budget deficit?

If the government continues to borrow from that same pool of savings, there will be fewer loans available for businesses and it will affect the overall economy.

What is a default?

It is a declaration by the government that essentially boils down to them admitting that they cannot pay its bills.

What happens when a government defaults?

Investors that loaned the government money loses billions, the government loses credibility, and it causes a massive recession.

Define what an exchange rate is.

It is the value of one nation’s currency versus the currency of another nation or economic zone.

A strong currency is good for…

Imports

A weak currency is good for…

Exports

When does a currency become more valuable?

Its value increases whenever demand for it is greater than the available supply.

When does a currency become less valuable?

It will become less valuable whenever demand is less than available supply.

Increased demand for a currency is typically the result of…

Higher levels of trade for money or speculative demand (high interest rates.)

Pegging is the practice of pegging their money to the currencies of others, usually the US dollar or the Euro. What do currency pegs do for an economy?

It creates stability between trading partners that can remain in place for decades.

The central bank of a country with a pegged currency must monitor which two factors?

Supply/demand, and the countries cash flow.

There are many factors that determine an exchange rate. Name at least 3.

Inflation, interest rates, and public debt.

A country with a consistent, low inflation rate, typically exhibits what?

A rising value in its currency as its purchasing power increases.

How do interest rates affect the currency exchange?

The ability to manipulate interest rates allows central banks to exert influence over inflation, and thus the value of the currency.

How do high interest rates affect the exchange rate? There are both bad and good sides to this answer.

Higher interest offers lenders in an economy a higher return relative to other countries, attracting foreign capital. However, if the inflation is much higher than in other countries, the benefits of higher interest rates are mitigated.

What is the current account?

It is the balance of trade between a country and its trading partners.

A deficit in the current account is indicative of…

An increased level of foreign trade, typically meaning that it is borrowing capital from foreign sources and thus needs more foreign currency that it receives.

Governments sell treasury bonds to do what? What is it also known as?

Treasury bonds are sold to raise money to cover government deficits and/or fund regular government operations. This is also known as public debt.

It is recognized that, in scenarios where the debt is very large…

That a government may print money to pay it off, inevitably causing inflation.

A large national debt is worrisome for foreign investors. Why is this the case?

They believe that there is a risk of the country defaulting on its debt, making them less willing to own securities dominated in that currency.

What do foreign investors seek out for?

Stable countries with strong economic performances.

Large foreign investment usually result in?

An increase in the countries currency.

Political turmoil typically causes what to happen?

Loss of confidence and a movement of capital to more stable countries.

The Canadian dollar exchange with American currency is heavily influenced by what?

Oil prices and exports.