3.6 - government debt, budgets, financing

government (national/ public) debt

amount of money that a government owes to lenders outside of the government itself

• accumulation of deficits minus surpluses

government budget

plan of a country’s revenues and expenditures over a period of time

balanced budget

expenditures = tax revenues

(*rarely happens)

budget deficit

expenditures > tax revenue

(*happens very often )

• financed by borrowing

budget surplus

expenditures < tax revenue

financing government debt with borrowing

• borrowing withing country

• borrowing from foreign countries

*great need for borrowing during recession to finance

• borrowing allows for continued spending without increasing taxes

sustainable debt

level of debt where government has

• enough revenues to meet its debt obligations (interest + repayment of borrowed amount)

• without accumulating arrears (overdue debt payments)

• while also allowing economic growth to continue at an acceptable level

ways of borrowing

• issuing bonds

• directly from financial institutions

issuing bonds explanation

• certificate that promises to pay interest at various intervals until the moment it is repaid to the bondholder.

  • holder of bond = lender

    • financial investors (individuals, firms, banks) have incentive to buy bonds because income they receive

  • issuers of bond = borrowers

measurement of debt

• debt-to-GDP ratio

  • share of rGDP od the borrowing country

costs of high levels of debt

• debt servicing costs → payment that must be made in order to repay the amount of the loan + interest

• poor credit ratings

debt servicing costs explanation

• debt servicing costs ↑ = opportunity costs↑ = money to spend on social services and infrastructure ↓

• when debt is from foreign lenders they must be repaid in foreign currencies

  • governments to pay use exports revenue

  • hence less money for imports

  • foregone imports = opportunity cost → negative consequences for economic growth

poor credit rating explanation

• high credit rating

  • pay back loans in full and on time without difficulties

• low credit rating

  • difficult to find investors

  • difficult to borrow from financial institutions

impacts of higher taxation and lower government spending

• to achieve budget surpluses

• increased income inequality

• lower private investment

  • loss of market confidence

• possibility of debt trap

• lower economic growth

reasons for increased taxation and decreased spending being politically unpopular

• reduced gov. spending and investment may lead to

  • fall in AD

  • fall in r GDP

    • deflationary gap

• hence → increased debt-to-GDP ratio

increased income inequality explained

• government debt ↑ = bonds issued ↑ = income distribution inequality ↑

  • buyers of bonds tend to be higher income people

    • when governments pay them interest it does it through tax revenues

    • transfer of income away from low income tax payers towards high income

debt trap

• country most keep on taking new loans in order to pay back the old ones