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To Accompany: “Economics: Private and Public Choice, 15th ed.” James Gwartney, Richard Stroup, Russell Sobel, & David MacphersonSlides authored and animated by: James Gwartney & Charles Skipton
Deficits, Surpluses, and the National Debt • National debt:
the sum of the indebtedness of the federal government in the form of interest-earning bonds. It reflects loans to the U.S. Treasury. • A budget deficit increases the size of the national debt by
the amount of the deficit. Conversely, a budget surplus allows the federal government to pay off bondholders and so reduce the size of the national debt. • The national debt represents the cumulative effect of all
• Of the $16.46 trillion debt, almost 40% is held by govt. agencies (primarily social security trust fund) and the Federal Reserve banks. The other 60.2% is held privately (domestic & abroad).
• Of the $9.91 trillion of privately held federal debt, 61.3% is owned by foreigners and 38.7% is held by domestic investors.
How Does Debt Financing Influence Future Generations?• How does debt financing influence future generations?• When considering this issue keep 3 key points in mind:• For domestically held debt (38.7% of total privately
held debt), the future generations that pay the tax liability accompanying the debt will also receive the interest income.• Debt financing of a government activity cannot push
the opportunity cost of the resources used by the government into the future. • Debt financing will influence future generations
How Does Debt Financing Influence Capital Formation?• How does debt financing influence capital formation?• There are two alternative views :• The new classical view:
People will increase their savings in anticipation of the higher future taxes implied by additional debt, leaving interest rates, consumption, and capital formation unaffected. • The traditional view:
Government budget deficits reduce future capital stock by increasing current consumption, pushing up real interest rates, and retarding private investment.
Gwartney-StroupSobel-MacphersonBorrowing from Foreigners
• Borrowing from foreigners accounts for approximately 60% of the federal debt.• If the foreign borrowing is used to finance productive
projects, future generations will inherit more productive assets that will make it possible for them to service the debt.• Alternatively, if the borrowing from foreigners is used to
finance current consumption or unproductive investment projects, the earnings from the additional capital formation will be insufficient to cover the interest payments. In this case, future generations of Americans are harmed by the debt financing.
Gwartney-StroupSobel-MacphersonBudget Deficits of 2001-2012
• As the U.S. experienced large budget deficits from 2001 to 2012, consumption increased as a share of GDP, private investment was weak, and trade deficits were large.• This pattern indicates that the current generation was the
• Social Security revenues and expenditures are generally included in budget deficit calculations.
• As the Baby-boom generation retires, the system will run larger and larger deficits. This will make it more difficult to balance the Federal budget in the future.
Social Security, Budget Deficits, and the National Debt
• Politicians like to spend in order to provide visible benefits to their constituents but they do not like to tax because this imposes a visible costs on voters.
• Debt financing makes it possible for politicians to spend now while pushing the visible cost of the higher taxes into the future.
• Unfunded benefits (like Social Security and Medicare) also make it possible for politicians to take credit for the promised benefit now without having to levy the equivalent amount of visible taxes.
• Thus, the political popularity of debt financing and unfunded benefits reflects the short-sightedness effect – the myopic nature of the political process.
• During 2009-2011, 40% of federal expenditures were financed by borrowing.
• The large deficits have pushed the federal debt as a share of the economy to levels not seen since WWII.
• The retirement of the baby boomers will push spending on Social Security and Medicare upward making it more difficult to control the growth of the federal debt.
Politics, Demographics, Federal Debt, and the Dangers Ahead
• What will happen if the federal government does not control the growth of its debt?
• Lending to countries with a large debt-to-GDP ratio is risky. As this ratio increases, governments will have to pay higher interest rates. This will make it still more difficult to control the budget deficit.• This happened in Ireland in 1986, Belgium in 1994,
and Greece 2011.
Politics, Demographics, Federal Debt, and the Dangers Ahead
Gwartney-StroupSobel-MacphersonQuestions for Thought:
1. Does the national debt have to be paid off at some time in the future? What will happen if it is not?
2. What is the difference between the national debt and the privately held federal debt? Is the difference between the two important? Why or why not?
3. "The national debt is a mortgage against the future of our children and grandchildren. We are forcing them to pay for our current consumption of goods and services."