宏观经济学 教案Chapter20.docx

CHAPTER 20THE NATIONAL DEBTChapter Outline The debt-to-GDP ratio The primary deficit Sources of government revenue Ownership of the public debt Sovereign debt The debt ceiling Austerity measures The debt crisis in the EurozoneChanges from the Previous EditionChapter 20 is a completely new chapter, although a few passages have been taken over from old Chapter 19. Figures 20-1 and 20-5 are updated versions of Figures 19-5 and 19-7, while Tables 20-1 and 20-2 are the previous Tables 19-9 and 19-8. Chapter 20 now deals exclusively with issues related to the national debt and the impact large debts (or the austerity measures taken to reduce them) can have on an economy. The chapter also points out that many arguments about the size of a public debt are more political than economic in nature. In Section 20-4 issues related to the recent debt crisis in parts of the Eurozone are discussed.Introduction to the MaterialIt is important to distinguish between the budget deficit and the national debt. A government runs a budget deficit if it spends more than it receives in tax revenues in a fiscal year. The national debt is the sum of all past budget deficits (or surpluses), that is, the sum of all of the unpaid obligations that the government has accumulated. A large national debt has important political as well as economic ramifications. However, rather than looking at absolute value of the gross national debt, which in the U.S. currently exceeds $16 trillion, it is much more important to consider the size of the debt-to-GDP ratio, which indicates how hard-pressed a country may be to handle its debt-burden. As long as a country's economy is growing faster than its debt, this ratio is decreasing, making it easier for the country to deal with the debt. However, when the ratio increases at a rapid pace for a sustained period, as it did in the 1980s and again during the Great Depression, it becomes worrisome. At some point creditors will become concerned that the debt will not be repaid and that concern can lead to a fiscal crisis. Currently the debt-to-GDP ratio in the U.S. is 107 percent, which is fairly high by U.S. standards.In highlighting the role of the national debt in a governments budget, it is useful to distinguish between the actual budget deficit and the primary (non-interest) budget deficit. Many of the U.S. budget deficits in the 1990s were actually more a result of high interest payments on previously incurred debt than of government spending exceeding tax revenues. Budget deficitsTechnical Problems.a. According to Table 20-2, total government outlays were 18.8% of GDP in the 1960s and 20.0% of GDP in 2000-09. Thus there was an increase of roughly 6.4% since the 1960s, which we can calculate in the following way:(20.0 - 18.8)/18.8 = 0.0638 = 6.4%.b. National defense decreased from 8.7% of GDP in the 1960s to 3.8% in 2000-2009. However, over the same time period, mandatory spending increased from 6.2% to 11.9% of GDP. This is now the largest component of government outlays.1 .c. The biggest contributor to increased government spending over the last four decades was the increase in outlays for entitlements. A minor contribution came from the interest payments on the national debt, which changed from 1.3% in the 1960s to 3.0% in the 1990s, but decreased again to 1.7% in 2000-2009.2 . The debt-to-GDP ratio is defined as the national debt divided by GDP. If the national debt grows by 5% a year, but GDP grows by only 4%, the debt-to-GDP ratio will increase.Empirical ProblemsUsing Excel to compare the values of the percent change in the debt-to GDP ratios from 1950 to the present for each of the two methods mentioned here to calculate them, one can see that the differences are fairly insignificant. Therefore one can conclude that the two calculation methods are basically equivalent.billion of dollarsNGDPNGDPdebtmos 二 M0OO66I ，一H046S 1Mo.i Hi IM079S ml Im o *oThe graph above shows the U.S. nominal GDP and the U.S. national debt (both in billions of dollars) from 1950 - 2012. While the difference between GDP and national debt changes over time can be seen, very little can be deduced about how the two variables relate to one another. The graph below shows the debt-to GDP ratio over the same time period and clearly indicates how this ratio behaves over time. The ratio decreases from 1950 to 1980 but then increases until about 1995. After a brief dip in the late 1990s, it starts to increase sharply after 2007一a result of the Great Recession.oercentdebt/gdpdebt/gdp1 mz 二 nss WCO62 1 10,34661 s二 006611 310,9861 Woo1I wws1 ml 1 310,9961 '§0.32 二 M0OOS6I二 m IMOOSSAdditional Problems1. When the federal government runs a budget surplus rather than a deficit, how will the public's bond holdings and the supply of money be affected?Any time the federal government has an excess of tax revenues over outlays, a budget surplus results. If the government uses the surplus to retire some of the existing national debt and repays government securities that are coming due, bond holdings by the public will decrease. But money supply will not change, unless the Fed wants high-powered money to change in accordance with the budget surplus. Assume that the budget surplus accumulates on the Tax and Loan Account (the receiving account of the Treasury), which is held at commercial banks. The Treasury can transfer the funds from the Tax and Loan Account to its payment account at the Fed, which will cause bank reserves to decline. If these funds are immediately used to retire government securities, bank reserves will increase back to their original level and high-powered money will not be affected. However, the Fed can always decide on its own to undertake open market operations to change bank reserves and thus high-powered money.2. Comment on the following statement:“The best way to cut the size of the U.S. budget is to sharply reduce defense spending, since the U.S. already is spending too much on its military."The answer to this question is student specific. Many students believe that the U.S. currently spends too much on the military. However, this is a value judgment and a case can be made for cuts in other spending as well. Few students realize that defense spending as a fraction of GDP is lower now than it was 40 years ago, while spending for social programs and interest payments on the debt has consistently increased. It is unlikely that a reduction in the size of the budget can be achieved successfully without cuts in entitlement programs.3. Should the government finance an increase in spending by raising taxes or by issuing more government securities? In your answer, discuss the relative merits of tax Hnancing versus debt financing of government spending programs as far as efficiency and equity are concerned.If government spending is financed by a tax increase, the increased income tax rate may provide a disincentive to work. If any other form of taxation is used, some other misallocation of resources may occur. If spending increases are financed through borrowing, the increased demand for funds will lead to upward pressure on interest rates, which will affect interest sensitive sectors in the economy. In other words, we will see some crowding out of private spending. The most interest sensitive sectors in the economy, such as the construction industry, agriculture, and banking, are affected to a larger degree than less interest sensitive sectors. Therefore deficit financing also leads to a misallocation of resources. Since investment is negatively affected by the increase in the cost of capital, the rate of capital accumulation will decrease and future living standards will be negatively affected.There is also the question of equity, since tax financing affects current taxpayers, whereas debt financing affects future taxpayers. In addition, it is important to consider whether those people who will benefit from the new spending programs are the same as those who will be affected by the tax increases.4. “An increase in government spending financed by borrowing from the public will increase the supply of money." Comment on this statement.When the government borrows from the public, the public gives the government money in exchange for bonds. If the government spends this money right away to purchase goods or services, money supply is not affected at all. This is simply a fiscal policy measure and does not involve the central bank. A link between a higher level of government spending and an increase in money supply only exists if the central bank follows a policy of pegging nominal interest rates at a certain fixed rate. In this case, open market purchases will be undertaken any time the government increases its borrowing from the public. The government's407 increased borrowing needs will put upward pressure on interest rates, but the central bank's open market purchases will increase bank reserves and keep interest rates from rising.In the U.S., the Treasury is not allowed to directly borrow from the Fed and thus fiscal policy is largely independent from monetary policy. But there are some countries where the government borrows heavily directly from the central bank through the printing of money. Under these circumstances, monetary and fiscal policies are much more closely linked.5. “The federal budget needs to be balanced every year so the national debt does not grow any larger." Comment on this statement.Balancing the federal budget annually does not make much sense since this would limit the government's ability to effectively use fiscal stabilization policy. If the economy were to go into a recession, a budget deficit would develop. To balance the budget, a cut in government spending or a tax increase would have to be implemented. But such measures would lead to a deepening of the recession, making balancing the budget even more difficult.6. Do you think that the flnancial crisis that started in 2008 and the recession that followed justified the massive increase in the size of the federal budget deficit? Why or why not? In your answer, state the size of the current budget deficit, the effects of large budget deficits on the economy, and the arguments for and against a balanced budget amendment.The answer to this question is student specific. During the recession of 200709, the U.S. Fed drove interest rates close to zero, so monetary policy could no longer be used to further stimulate the economy. Therefore, expansionary fiscal policy was needed. As a result, the budget deficit ballooned to about $1.5 trillion before it eventually started to decrease again. While this massive increase may be justified by the need to stimulate the economy, future generation may suffer a decrease in living standards as a result. Higher budget deficits cause interest rates to rise, which crowd out investment, leading to a lower rate of capital accumulation and lower future economic growth and thus a lower future living standard. If the deficit is financed internally, there is a redistribution of income since the taxes raised to pay off the deficit will be used to pay government bondholders. If the deficit is financed from abroad, then foreigners have to be paid off and this creates a burden on future generations. Higher interest rates cause an inflow of funds, an appreciation of the domestic currency, and a higher trade imbalance, thus leading to a loss of domestic jobs. The high interest rates may induce the Fed to increase money supply in an effort to lower interest rates, which can be inflationary, causing a redistribution of income and wealth. On the other hand, many government projects that build up the infrastructure have long-term benefits for future generations, so some current government spending will actually lead to higher living standards in the future. We should note that the actual size of the budget deficit (or national debt) is less important than its size relative to GDP. It is worrisome when the national debt grows faster than GDP.408Balancing the federal budget annually does not make much sense, since the government would have to give up its ability to use fiscal stabilization policy effectively. If the economy were to go into a recession, a (cyclical) budget deficit would develop. To balance the budget, a cut in government spending or a tax increase would have to be implemented. But such measures would lead to a deepening of the recession, making balancing the budget even more difficult.7. True or False? Explain your answer.“The U.S. debt-to-GDP ratio has been steadily declining since World War II, when it was at an all-time high.”False. The debt-to-GDP ratio is the size of the national debt divided by the size of nominal GDP. It is true that the debt-to-GDP ratio was at an all-time high at the end of World War II and declined significantly until the 1970s, since the economy was growing faster than the debt. However, the ratio started to increase again in the 1980s as the size of the national debt increased at a faster pace than GDP. In the late 1990s, this trend reversed as the economy grew stronger and budget surpluses developed. However, by 2002 the federal government was again running a deficit and by 2013, the debt-to-GDP ratio had increased to 107 percent, still lower than in the early post-war years but the highest it has been since then.8. “The recent sharp increase in the U.S. national debt reduced national saving and this was the primary reason for the low level of investment spending during the last recession.” Comment on this statement. In your answer, explain what factors may affect investment spending.It is true that an increase in the national debt due to expansionary fiscal policies can lead to higher interest rates and thus a decrease in private investment spending. However, investment spending depends not only on interest rates but also on sales expectations, that is, business expectations about future economic performance. Since the economy was in a major recession and the Fed injected a huge amount of money into the economy, interest rates declined and remained low. Therefore, the decrease in investment spending must be blamed on low sales expectations by businesses. Besides interest rates and sales expectations, investment spending also depends on many other factors, such as inflationary expectations, corporate income taxes, capacity utilization, credit availability, etc.9. “The central bank can lower the budget deficit through open market purchases.” Comment on this statement. In your answer discuss whether money Hnancing or debt financing is more inflationary.Open market purchases increase bank reserves and thus money supply. This lowers interest rates, leading to a higher level of investment and income. Since income tax revenues increase409in a boom, the budget deficit decreases. Lower in