Deficits, Surpluses, and Debt: Definitions

  • Budget deficit: the amount by which government expenditures exceed government revenues in a given year.
    • 2002: Federal government spent $2011 billion while taking in revenues of $1853 billion.
      • $1853 billion - $2011 billion= $158 billion deficit.
  • Budget surplus: the amount by which government revenues exceed government expenditures in a given year.
    • 2000: Revenue - $2025 billion/Expenditures = $1789
      • $2025 billion - $1789 = $236 billion surplus
  • Public debt: total accumulation of the deficits (minus the surplus) the Federal government has incurred through time (beginning with the 1st president).
    • Represents the total amount of money owed by the Federal government to the holders of U.S. securities (Treasuring bills, notes bonds, and U.S. saving bonds).
      • 2002: the amount was $6.2 trillion.
      • The public debt is now $15.6 trillion.

Budget Philosophies

1) Annually Balanced Budget: A budget in which government expenditures and tax collections are equal each year.
  • During times of unemployment and falling incomes, government should balance the budget by 1) increasing tax rates, 2)reduce government expenditures, 3) do both.
    • However, these are all contractionary.
  • During times of rising incomes and inflation, the government must 1) cut tax rates, 2) increase government expenditures, 3) do both.
    • These are all expansionary.
    • Expansionary fiscal policy involves increases in spending, decreases in taxes, or a mixture of both.
  • As seen, this philosophy is said to "intensify the business cycle", or "worsen" the cycle.
    • increase tax rates
    • reduce government expenditures
    • or do both
  • All of these actions are contractionary, meaning it decreases aggregate demand (does not expand)

2) Cyclically Balanced Budget: The equality of the government expenditures and net tax collections over the course of a business cycle. Deficits incurred during periods of recession are offset by surpluses obtained during periods of prosperity (inflation)
  • Enabled the government to exert a counter-cyclical influence and at the same time, balance its budget.
  • They believe that the budget does not have to be balanced annually, but should be balanced over the course of the business cycle
  • To offset recession, the government should lower taxes, increase spending, purposefully causing a deficit. During the inflation, the government would then raise taxes and cut spending, creating a profit
  • One problem with this budget philosophy is that positive and negative periods of the business cycle are not always equal in magnitude or occur for the same length of time (McConnell 326).
3) Functional Finance: is the use of fiscal policy to achieve a noninflationary full-employment GDP without worrying about the effect of public debt
  • Is often concered with annually or cyclically balance budged
  • It's main purpose is to provide noninflationary full employment to balance the eocnomy rather than the budget
  • If it causes then deficits or persistent surplus then thats okay because in the governments eyes those issues are minor compared to prolonged recession or inflation
  • The Federal Budget is key for achieving and maintaining marcro stability

Keynesians emphasize the use of fiscal policy to spur demand whenever it is needed, deeming necessary in order to spur the economy.

Causes of Public Debt

  • Wars: In times of war national defense spending dramatically increase, therefore increasing the amount of debt
    • In the second world war, the government sold bonds to finance the war which resulted in a large public debt as the government would have to pay back those bonds eventually
  • Recessions: During a recession, the government's revenue decreases due to less disposable income held by the public. In addition, the government is often expected to take some course of action that requires spending, which also creates public debt. Keynesian philosophy encourages deficit spending to spur demand, pushing the economy out of a recession through chain-reaction spending.
  • Lack of Fiscal Discipline: Illogical decisions made by elected leaders also contributes to the public debt. The government often takes actions that many economists would consider to be 'wrong' given the situation, which leads to a worse economy and more spending. (McConnel & Brue 327)
  • To increase Federal Spending and to reduce Federal tax rate-has at times produced large federal budget deficits.(McConnel & Brue 327)
  • about one fourth of the U.S. debt is owned by the Federal reserve, and other government agencies, while the rest is owned by individuals, investments, and banks

Crowding Out

  • The idea behind the crowing out effect is that if the government is to maintain a significantly large national debt, the interest rates will be higher. As a result, these higher interest rates will defer or lessen gross private domestic investment (McConnell and Brue 331).
  • With private investment lowered, there will be a smaller supply of capital goods.
    • Public investments can lessen the impact of the reduction in private investments.
      • The idea behind this is that government may use some of the money from the finances resulting in the increase of national debt, for public investments.
      • To some extent, these increases in public investment may serve as a substitute to private investment, and may lower the impact of the crowding out effect.
        • For example, infrastructure, such as roads and transportation systems, may be one area of potential public spending that can abound.
      • It also possible for there to be an influx in private investments as a result of the increased public investment. Firms may find the anticipated profits to have risen, because of the public investments.
        • For example, the roads may facilitate quicker transport for the factories of the firm, and increase productivity. The firm may, therefore, be able to produce its outputs at a faster rate, and this may lead to greater profits.[1]

Deficits and Surpluses

  • growth or shrinkage of public debt depends on deficits and surpluses of each fiscal year (McConnell and Brue 332)

What to do with Surpluses
  • Pay off public debt is often a choice
    • benefits are possible growth in the long run, since the government will not need to borrow so much money and the crowding out effect will be lessened (McConnell and Brue 333)
    • The government could also cut taxes, increasing spending and therefore GDP
      • Supporters of this approach stated that the surplus revenues should be returned to taxpayers (McConnell 333).
    • Increasing federal expenditures is another option (McConnell 333).

False Conerns

  • There are concerns in which large public debt may bankrupt the U.S. or put a burden on future generations. These concerns about going bankrupt and not being able to refinance, are wrong.

The public debt does not threaten to bankrupt the Federal government so there are two options they can do Refinancing and Taxation (McConnell and Brue).
  • Refinancing: Selling new bonds and paying off new bonds with money received from selling new bonds.
  • There are a great deal of people who will buy the bonds since they have good pay back interest.
  • Taxation: They can also levy and collect taxes to pay off different things and to finance debt.

Substantive Issues

  • There are several substantive issues relating to public debt that are of varying importance (McConnell and Brue 330).

Income Distribution:
  • The distribultion of government securities is extremely fluctual. In general, most public debt is concentrated among wealthy people who hold lots of stocks and bonds.
  • Payment of interest on public debt increases income inequality (McConnell and Brue 330).
  • Large public debt may impare economic growth (McConnell and Brue 330)
  • The incentive to innovate, invest, and bear risk is reduced due to higher taxes (McConnell and Brue 330)
Foreign-Owned Public Debt:
  • The 18 percent of the U.S. debt held by citizens and institutions of foreign countries is an economic burden to Americans. (McConnell and Brue 330)
  • They payment of interest and principal on this external public debts enables foreigners to buy some of our output. (McConnell and Brue 330)

External public debt: Public debt owed to citizens and institutions of foreign countries (McConnell and Brue, 330).

Crowding Out and the Stock of Capital
  • Crowding out effect: It is when a large public debt leads to higher real interest rates. As a result, there is less private investment spending (McConnell and Brue, 331).

  • Public Investments: Investments made on services for the public (McConnell and Brue, 331).

  1. ^ McConnell, Campbell R., and Stanley L. Brue. Economics: Principles, Problems, and Policies. Sixteenth ed. New York: McGraw-Hill, 2005. Print.