Budget Deficits and the National Debt

1
Budget Deficits and the National Debt

• What determines Budget Deficits?
• Budget Deficits and the Business Cycle
• Burdens of the National Debt
• READINGS Ch 4, p123-126, Ch 15.1-15.3

2
Figure 15.1 Government outlays Federal, state,
and local, 1940-2005
3
Table 15.1 Government spending in Eighteen OECD
Countries, Percentage of GDP, 2005
4
Figure 15.2 Taxes Federal, state, and local,
1940-2005
5

• Some definitions
• Budget Deficit (BD) G TR INT T
• ( -Sg)
• Primary BD G TR T
• The BD for 2006 is about 200 billion.
• The national debt is the total stock of
  outstanding debt of the Federal government.
• The current national debt 9.2 Trillion.

6
Figure 15.4 Deficits and primary deficits
Federal, state, and local, 1940-2005
7
Actual and Full Employment BD

• Question What determines the size of the BD?
• Total taxes (T) can be expressed as
• T T0 tY
• (lump-sum taxes) (marginal income
  taxes)
• Factors which affect BD
• (1) Government purchases (G) G ? BD
• (2) Tax Policies (T0 ,t) T0,t ? BD
• (3) Real GDP (Y) Y ? BD

8

• The full employment budget deficit (FEBD) is the
  budget deficit which would occur if the economy
  were at
• (i) Actual Y will not affect FEBD.
• (ii) Only fiscal policy (G,T0,t) will affect
  FEBD.
• A marginal income tax system provides the economy
  with automatic stabilizers.

9
Figure 15.5 Full-employment and actual budget
deficits, 1960-2005
10
Budget Deficits and Ricardian Equivalence

• Two approaches to how BD affects economy
• (i) Keynesian (IS-LM)
• (ii) Classical Ricardian Equivalence.
• Governments budget constraint
• G T (Gov Bonds) (Money Creation)

11

• The Ricardian Equivalence proposition For a
  given level of government purchases,
• - financing by either taxes or bonds (deficits)
  have equivalent effects on real GDP and
  economy.
• - A tax cut will have no effect on real GDP.

12

• Problems
• (1) Shortsighted/Irrational
• (2) Concern for Future generations (bequests)
• (3) Imperfect capital markets / Borrowing
  constraints.
• (4) Non-Lump Sum Taxes.

13
Burdens of the National Debt

• Popular argument
• Budget deficits are bad because they place a
  burden on our future generations who will have to
  pay it off.
• every man, woman, and child owes 29,000
• National Debt Clock http//www.brillig.com/debt
  _clock/

14

• True Burdens of National Debt
• Is it Foreign or Domestic Borrowing?
• Is it Government Consumption or Government
  Investment?
• Whats the Impact on National Saving?
• Whats the Debt-to-GDP Ratio?

15
Figure 15.6 Ratio of Federal debt to GDP,
1939-2005