1 Chapter 17 Federal Deficits and the National Debt Key Concepts Key Concepts Summary 2000 South-Western College Publishing.

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Chapter 17 Federal Deficits and

the National Debt• Key Concepts• Summary

©2000 South-Western College Publishing

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What is the purpose of this chapter?

To take a closer look at the actual budgetary process that creates and finances our national debt

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What are the four stages of the budget process?

• Formation of the budget• Presidential budget submission• Budget resolution• Budget passed

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Formation of BudgetFebruary – December

(previous year)

Presidential Budget SubmissionJanuary

Budget ResolutionMay

Budget PassedSeptember

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What is thefederal fiscal year?

October 1 through September 30

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What is thefederal deficit?

How much money the government borrows in any given fiscal year

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What is thenational debt?

The total amount owed by the federal government to owners of government securities

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How does the U.S. treasury borrow money?By selling Treasury bills,

notes, and bonds, promising to make specified interest payments and to repay the loaned funds on a given date

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60$200

Bill

ions

of d

olla

rs

$400

$1,600

$600$800

$1,000$1,200$1,400

65 70 75 80 85 90 95

Expenditures

Revenues

00Year

$1,800Federal Expenditures and Tax Revenues

10

17

Perc

enta

ge o

f GD

P

18

24

1920212223

1985 1990 1995 2000

Federal Expenditures, Revenues, and Deficits as a Percentage of GDP

Federal Deficit

Year

11

65

$-300

0

$-200

$-100

70 75 80 85 90

Deficit

95

Federal Budget Surpluses and Deficits

Bill

ions

of d

olla

rs

60

Surplus$+100

00

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What is a debt ceiling?The legislated legal limit

on the national debt

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What usually happens when the debt pushes against the ceiling?

Congress raises the ceiling to accommodate the budget deficit

1430 40 50 60 70 80 90

Year$1$2$3

$4

$5

$6

National debt

The National Debt

00

Tri

llion

s of d

olla

rs

1530 40 50 60 70 80 90

Year20406080

100 National debt/GDP120140150

Perc

enta

ge o

f GD

P World War II

The National Debt as a Percentage of GDP

00

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What is the internal national debt?

The portion of the national debt owed to a nation’s own citizens

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What is the external national debt?

The portion of the national debt owed to foreign citizens

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0%

20%

40%

60%

80%

100%

120%

140%

An International Comparisonof National Debt Ratios as a percentage of

GDP, 1998

ItalyCanadaJapanU.S.GermanyFranceU.K.

1940 50 60 70 80 90 00

.05%1.0%1.5%2.0%2.5%3.0%3.5%4.0%

Federal Net Interest as a Percentage of GDP

Year

Perc

enta

ge o

f GD

P

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Ownership of the National Debt1999

36%

18%

46%

Public Sector

Private Sector

Foreigners

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What is thecrowding-out effect?

When federal government borrowing increases interest rates, the result is lower consumption and investments

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Can the government go bankrupt?

• Yes, it’s possible• No, the debt need never

be paid off

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Are we passing the debt burden to our children?Yes, especially if it

continues to increaseNo, not as long as the debt

is internally owned

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Does government borrowing crowd out

private-sector spending?Yes, the more the government

borrows the less loanable funds for everyone else

No, especially if it occurs during economic downturns

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200

150

50

2 4 6 8

AD1

AS

AD`2100

12

AD2

E2

E1

E`2

Full Employment

Complete (AD1), Partial (AD`2), and Zero (AD2) Crowding Out

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Government spends & borrows

Government competes with private borrowers

Interest rates rise

Consumer & business spending decrease

AD and real GDP increase dampened

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Key Concepts

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Key Concepts• What is the Federal Deficit?• What is the National Debt?• How does the U.S. Treasury borrow money?• What has been done to curb the National Debt

?• What is a Debt Ceiling?

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Key Concepts cont.• What is the Internal National Debt?• What is the External National Debt?• What is the Crowding-out Effect?• Can the Government go Bankrupt?• Are we passing the Debt Burden to our

Children?• Does Government Borrowing Crowd Out

Private-sector Spending?

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Summary

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The national debt is the dollar amount that the federal government owes holders of government securities. It is the cumulative sum of past deficits. The U.S. Treasury issues government securities to finance the deficits. The debt has more than tripled since 1980. The debt ceiling is a method to restrict the national debt.

3230 40 50 60 70 80 90

Year$1$2$3

$4

$5

$6

National debt

The National Debt

00

Tri

llion

s of d

olla

rs

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Internal national debt is the percentage of the national debt a nation owes to its own citizens. In 1998, abut 83% of the national debt was internally held by individuals, banks, corporations, insurance companies, and government entities. The “we owe it to ourselves” argument over the debt is the U.S. citizens own the bulk of the national debt.

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External debt is a burden because it is the portion of the national debt a nation owes to foreigners. The interest paid on external debt transfers purchasing power to other nations. In 1998, approximately 17% of the national debt was external.

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Ownership of the National Debt1999

36%

18%

46%

Public Sector

Private Sector

Foreigners

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The crowding-out effect is a burden of the national debt that occurs when the government borrows to finance its deficit, causing the interest rate to rise. As the interest rate rises, consumption and business investment fall.The burden of debt debate involves controversial questions:

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Can Uncle Sam GO Bankrupt?The national debt is a lower percentage of GDP today than at the end of World War II. The U.S. government will not go bankrupt because it never has to pay off its debt. When government securities mature, the U.S. Treasury can refinance or roll over the debt by issuing new securities.

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Are We Passing the Debt Burden to Our Children? NOOne side of this argument is that the debt is mostly internal, so financing a deficit only involves exchanging old bonds for new bonds among U.S. citizens. The burden of the debt falls only on the current generation when the trade-off between public-sector goods and private sector goods along the production possibilities curve occurs.

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Are We Passing the Debt Burden to Our Children? YESThe sizeable external debt transfers purchasing power to foreigners.

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Does Government Borrowing Crowd Out Private Sector Spending? Keynesian theory assumes zero crowding out when the federal government increases spending in order to shift the aggregate demand curve rightward. If crowding out occurs, reduced private spending offsets the multiplier effect of increased government spending. As a result, the expected magnitude of the rightward shift in the aggregate demand curve is partially or completely offset.

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END