ECON 202 Principles of Economics: MACROECONOMICS Phil Martinez UPDATED 11/6/12

I. Definitions & Basics

Budget Deficit/Budget Surplus

Cyclical Deficit and Structural Deficit

National or Public Debt
       Short Run Debt and Long Term Debt

Discretionary Spending

Automatic Stabilizers

Crowding In versus Crowding Out

Deficit spending is financed by the government borrowing funds from the private financial sector through the sales of government Treasury bonds.

II. Facts

A. Causes of Deficits and Debt

Note that in the graph above all of the major increases in the U.S. government debt are easily identified as periods of:

1. Wars

2. Recessions

3. Discretionary Expansionary Fiscal Policy

Wars are always funded by borrowing since raising taxes to cover wartime expenses creates opposition to the war effort, and because it makes no senses to place a budgetary limit on war expenses ast his simply encourages the enemy to wait out the spending cycle.

Recessions automatically generate deficits and increase the debt because tax revenue falls as firms earn less profit or close down, and households lose income due to layoffs and unemployment. Additionally, spending on social services automatically rises as more people qualify for unemployment insurance, food stamps, housing subsides, et cetera. Income taxes and social spending are called automatic stabilizers because they automatically increase when the economy goes into recession and decrease as the economy expands, helping to self-balance the economy as they move counter-cyclically.

The article below highlights the impact of war spending, tax reductions, and increases in descretionary spending on the debt during the Bush and Obama administrations.

 
 B. History of U.S. Government Debt

1. Prior to Great Depression:

Deficits oscillated with surpluses and balances. Debt was less than 5% of GDP through the 1910s, rose to 10% of GDP during the 1920s.

2. During Great Depression:

Hoover balances budget (cuts gov't. spending in '30 - '32), this worsens the depression.

Roosevelt runs major deficits with major anti-poverty, back-to-work programs, e.g. the Civilian Conservation Corps (CCC), the Work Projects Administration (WPA), unemployment insurance, social security, et cetera. This stimulates recovery. However, in 1936 tries to balance budget in anticipation of election. In 1937 the economy has its second crash and re-enters recession (the second dip of the  depression). Both the deficit and debt increase.

3. WWII:

Military spending accelerates US gov't. deficit spending and debt to highest levels ever (a possible exception is the American Revolutionary War). Debt rises to near 130% of GDP.

4. Post WWII era:

Debt falls to approximately 28% of GDP by 1980.

 

5. 1970 - 1980:

Small deficits begin to rise slightly building-up debt in the 1970's.

6. 1981 - 1992:

Small deficits continue due to recession in 1980-82.

Deficits & Debt triple due to Reagan era Supply-Side "Trickle-Down" Tax cuts (1981-84) which were not matched with equivalent spending cuts. This is the largest deficit & debt increase in US history due to discretionary fiscal policy. It was also intentionally implemented as a method to force the US economy into crisis in order to achieve the political goal of cutting government programs (see Stockman article).

7. 1992 - 2002:

Surpluses due to 10-year expansion, small tax increase, and productivity-focused Supply-Side government support for high-tech infrastructure and research and development.

8. 2002 - 2007:

Deficits return in 2002, due to

- recession,

- Bush Admin. tax cuts,

- increased government spending on post-September 11 bailouts and security, Afghan & Iraq wars, expanded Medicare perscription coverage.

Again, as a "Starve the Beast" strategy, the Bush administration deficit spends (via tax cuts not matched by spending cuts) and raises the debt intentionally to create a fiscal policy crisis and force spending cuts in the future. (See Stockman article #2).

9.  2008 - 2011:

The Great Recession: Largest recession since the end of WWII. Largest financial collapse since the Great Depression. Results in rapid increase in deficit.

- Bush Administration passes $780 Billion financial bailout (October 2008).
- Obama Administration passes $787 Billion stimulus bill - American Recovery and Reivestment Act. $288 Billion of the stimulus is in tax cuts (Feb. 2009).
- Obama Administration passes $858 Billion tax cut, an extension of Bush Admin. tax cuts (Dec. 2010) .
- Tax revenue plummets, deficits expand.

 

1. The US Federal Government Budget is like a household or commercial budget, which must be balanced. So the government should be required to balance its budget.

NOT TRUE. The government budget is NOT the same as a household budget, since:

- The government can raise its income simply by raising taxes. Households cannot simply decide to give themselves raises.

- The government can allow inflation to increase tax revenue and reduce it's debt repayment, households can't. This is not a good idea for a long term solution, but it is a policy option households do not have.

- Neither households nor firms necessarily balance their budgets. Firms both lose or save money in any given year. Households deficit spend anytime their annual expenditures exceed their annual income. For example, when they buy a house, or increase a balance on a credit card.

In the bar graph below, note that for most countries, including the U.S., government debt is far smaller than private sector debt. For the U.S. the government debt is smaller than household debt, and smaller than non-financial business debt. The financial sector's debt is nearly as large as the U.S. government debt. Also note that the U.S. debt load, public and private, is not excessive compared to other developed nations.

2. The federal government budget is like state government budgets. State governments balance their budgets, so the federal government ought to as well.

NOT TRUE. The federal deficit is partly due to the federal government's subsidies of state budgets. These federal government subsidies to states allow the states to actually spend more than they take in via tax revenue. Thus, the federal government, deficit aggregates all the state's deficits, allowing them to post a balance.

 

3. US deficits are way too large and threaten the health of the US economy.

NOT TRUE, although U.S. debt is approaching 70% of GDP. US deficits are at the high end  compared to other developed nations. Japanese national debt is above 200% of GDP. Greece and Italy are above 120%. Germany and France are at or above 80%, and the U.K. is above 75%. (Estimate from CIA World Factbook, c. Jan. 2011). The U.S. had a debt of 130% of GDP at the peak of WWII. Additionally, as of May 2011, the US remains the safest borrower in the world, paying the lowest interest rates on its government bonds; and maintains the dominant world currency.

4. The best way to evaluate a deficit or debt is to measure its total size, and its relative size as a percent of the GDP.

NOT TRUE. The best way to evaluate deficits is based upon the MC/MB of the specific expenditures and programs supported by the deficit:

Is the benefit of the funded program worth the cost of paying off the debt that is incurred by that program?

With respect to debts, the method used is to compare the value of the debt (liabilities) versus the value of assets:

Are assets large enough to payoff the debt?

 

5. Future generations of taxpayers should not be stuck paying off debt accumulated in the past.

NOT TRUE. It is appropriate for future generations to pay off debt accumulated in the past, when they were among or were the primary beneficiaries of the programs funded by the debt. . E.g. education, child health, infrastructure, etc.

6. The government debt puts the US in a vulnerable situation by being over-indebted to foreign countries.

NOT TRUE, although foreign ownership of U.S. debt is rising.  U.S. government agencies (Federal, state, and local) own 50% of all of the Treasury bonds sold to finance the debt. Another 22% is owned by the U.S. Federal Reserve, American citizens, banks, corporations, insurance companies, and other American firms. Only 25% of the debt is owed to foreign investors (both foreign private investors and foreign governments.

7. Debt/deficit ceilings (e.g. OR "kicker" law) are necessary to keep the government budget balanced.

NOT TRUE. Debt/Deficit ceilings have been ineffective. Deficit/Debt ceilings are really just political mechanisms for forging compromises on how to use budget surpluses or deficits. If they were effective, they would remove fiscal policy as a stabilizing tool. Additionally, if effective they would require cutting government spending during a recession, thus, requiring pro-cyclical fiscal policy, making arecessions worse.