ECON - Control of the National Debt

What is a budget deficit?

When the government spends more than it receives.

What are the two types of budget deficit?

• A cyclical deficit - Caused by economic downturn.

• A structural deficit - A deficit that is ongoing and is not caused by any short term macroeconomic fluctuations.

When the budget deficit and national debt are expressed as a percentage of GDP :

• If GDP growing fast, cyclical deficit is likely to improve, so the ratios of the budget deficit to GDP and national debt to GDP are likely to fall.

• If there is a recession, the cyclical budget deficit will deteriorate, so the ratios of the budget defict and national debt to GDP will rise.

What is the National Debt?

It is the debt __owed by__ the Government.

Who is the National Debt owed to?

• UK Citizens through the savings they have accumulated through pensions.

• 25% of National Debt is is owed to the BofE.

• The remainder is financed through the sale of government bonds to individuals and institutions.

What are the different types of government expenditure?

• Capital expenditure.

• Current expenditure.

• Transfer Payments.

• Debt interest.

What is government __Capital Expenditure__?

Spending on investment goods that will increase the productive capacity of the economy. E.g. Motorways, Schools, Hospitals, Bridges.

What is government __Current Expenditure__?

Spending covering the day-to-day runnings of public sector services. E.g. Teachers wages, heating and lighting in hospitals, Grit used on winter roads.

What are government __Transfer Payments__?

Form of __Current Expenditure__ that are mainly welfare payments made to individuals. E.g. State pensions, Child benefit.

What are government __Debt Interest Payments__?

The interest the government pays on national debt. (Form of __Current Expenditure__).

Budget deficits may result from either :

• Discretionary Government Policy. Chosen to happen.

• Automatic Government Policy.

What is %%Discretionary%% Fiscal Policy?

%%Deliberate%% decision making by the government to change __tax rates/law__ or change levels of __Government Spending__.

What is %%Discretionary%% Monetary Policy?

%%Deliberate%% decision making by the BofE to change things like __Interest rates__ or __Quantitative Easing__.

What is ^^Automatic^^ Government Policy?

Automatic government policy comes about when there are built-in stabilisers in the economy. These are expenditures which automatically increase when the economy is going into recession and vise versa.

**[Implications of the National Debt]** What is the __opportunity cost__ of interest payments?

The money expected to be spent on making interest payments could be used for more productive purposes.

**[Implications of the National Debt]** Increase in __borrowing costs__ :

Government borrowing increases the total demand for credit in the economy, driving up the cost of borrowing in the process.

**[Implications of the National Debt]** What is __Crowding Out__?

The Government needs to sell its guilts at attractive interest rates to entice investors away form alternatives. This means less private investment into businesses and real jobs.

**[Implications of the National Debt]** __Exchange rate falls__ :

30% of the UK Government’s debt is financed by overseas borrowing; if overseas investors lose confidence and sell their debt, this can cause a lowering of the exchange rate.

**[Implications of the National Debt]** __Inequity over who pays__ :

Government debt implies future taxpayers will be responsible for repaying debt that might have been incurred before they were born.

**[Implications of the National Debt]** __Slower economic growth__ :

If borrowing increases faster than real GDP. Gov’ borrowing may require higher tax rates, which could lead to slower economic growth.

**[Implications of the National Debt]** __Risk of Credit Downgrades__ :

Credit ratings for countries are set by private firms like Moody’s and Standard and Poor’s. Credit ratings estimate the likelihood of a country or firm of paying off debts. The lowerthe credit rating, the higher the rate of interest demanded to buy the debt issued.

What is Crowding __In__?

When extra government spending leads to high private sector spending through the multiplier effect.

What is Crowding __Out__?

When extra public spending leads to reduced private sector spending.

How could a fiscal surplus help the national debt?

The debt is cut in money terms.

How could balancing the government’s finances help the national debt?

Commbined with economic growth, national debt could be reduced as a percentage of GDP.

How could inflation help the national debt?

The real value of debt is reduced - Assuming Gilts aren’t index linked.

How could Quantitative Easing help the national debt?

It is a way of printing money to finance their deficits; therefore, more QE will reduce the national debt held outside the BofE.

What is a last resort solution to the national debt?

Defaulting on their debts - This has a large economic cost for the economy. Greece and Spain have done this.