Government Deficits and Debts (APDC)

Government Deficits & Debt

Deficit vs Debt

• Deficit: When government expenditures exceed revenue.

• Debt: The total accumulation of all prior year’s budget surpluses and deficits.

Understanding the Federal Budget

• Federal Budget Deficit:

  • Net Income of the Federal Government calculated as Income – Expenditure.

  • Taxes minus Government Expenditure results in negative for deficits.

• Surplus: Occurs when expenditure is less than revenue, resulting in positive net income.

• Balanced Budget: Expenditures equal revenue, resulting in no deficit or surplus.

• The US Federal Government consistently runs a deficit due to annual expenditures exceeding tax revenue.

• Treasury Securities (Bonds): Used to fund government spending when tax revenue is insufficient.

National Debt Impact

• Public Debt: Increases with deficits and decreases with surpluses.

• Reducing debt requires either increasing revenue (taxes) or decreasing spending.

• High levels of public debt can impede long-run economic growth.

Holders of US Government Debt (Dec 2021)

• 40.94% is held by Federal Reserve and governmental accounts.

• Other significant holders include mutual funds (11.09%), depository institutions (5.87%), and various pension funds.

Federal Surplus or Deficit

• Historical data shows the Federal Surplus or Deficit as a percentage of GDP was lower in recent years compared to historical highs during the 20th century, with fluctuations indicating economic conditions.

Implications of Debt

Assessing the National Debt

• Negative Implications:

  • Increased debt levels may hinder long-term economic growth.

  • Higher interest rates can lead to less capital formation and lower potential output.

  • Loss of international confidence in the US dollar could result in reduced foreign investment.

• Positive Considerations:

  • Most US debt is held domestically, providing a buffer.

  • As long as interest payments are made, the immediate debt due remains manageable.

  • A good credit rating permits borrowing at low interest rates, potentially promoting economic growth when managed wisely.

Fiscal Policy Considerations

"Crowding Out" Effect

• Increased government spending leads to a greater demand for loanable funds, raising real interest rates.

  • Higher interest rates reduce private business investment, leading to fewer new capital goods and lower long-term economic growth.

  • Strengthened demand for the dollar results in reduced net exports, as the currency appreciates, thereby making exports more expensive and imports cheaper.

Automatic Stabilizers during Economic Downturns

• Progressive Taxation: Tax rates rise with income increases, automatically adjusting to economic conditions.

• Unemployment Insurance: Government expenses rise with unemployment rates, leading to increased deficits and decreased surpluses during recessions.

Summary of Key Concepts

• Definitions:

  • Deficit: Excess of expenditures over revenue.

  • Debt: Total of past budget deficits and surpluses.

  • Budget Surplus: When revenue exceeds expenditures.

  • Balanced Budget: When revenues equal expenditures.

• Automatic Fiscal Policy can disrupt balanced budgets causing shifts towards deficits, particularly during economic downturns.

• Debt Ceiling: Legal limit on the debt amount that the US Treasury can issue, influencing fiscal policy.

• While government debt can challenge economic stability, it may also boost long-run growth if directed towards productive investments in areas like education and infrastructure.