Transcript McGraw-Hill/Irwin - McGraw Hill Higher Education

Chapter 31
POLITICS, DEFICITS, AND
DEBT
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Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
31-2
Today’s lecture will:
• Define the terms deficit, surplus,
and debt.
• Distinguish between a passive
deficit and a structural deficit.
• Differentiate between real and
nominal deficits and surpluses.
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31-3
Today’s lecture will:
• Explain why the debt needs to be
judged relative to assets.
• Describe the historical record for the
U.S. deficit and debt.
• Summarize the current debate about
Social Security and Medicare and
identify the real problem and the real
solution.
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31-4
Defining Deficits and Surpluses
• A deficit is a shortfall of revenues under
payments.
• A surplus is an excess of revenues over
payments.
• In the short run, if the economy is below
•
potential, deficits are good and surpluses are
bad because deficits increase expenditures
moving output closer to potential.
Long-run surpluses (excesses of revenues
over payments) are good because they
provide saving for investment.
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31-5
Financing the Deficit
• The government finances its deficits by
•
•
selling bonds to private individuals and
the Fed.
Bonds – promises to pay back the money
in the future.
The Fed can print an unlimited amount of
money to buy bonds, but printing too
much money can cause inflation.
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31-6
Arbitrariness in Defining
Surpluses and Deficits
• Whether a nation has a deficit or surplus
•
•
depends on what is included as revenues and
expenditures.
Deficit and surplus figures are summary
measures of the financial health of the
economy.
What’s important is not the surplus or deficit,
but whether the economy is healthy.
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31-7
Structural and Passive Deficits
• Many government revenues and
•
•
expenditures depend on the level of
income in the economy.
Structural deficit – the part of the budget
deficit that would exist even if the
economy were at its potential income.
Passive deficit – the part of the deficit that
exists because the economy is operating
below its potential level of output.
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31-8
Structural and Passive Deficits
• There is disagreement about what percentage
•
•
•
of a deficit is structural and what part is
passive.
Actual deficit = structural deficit +
passive deficit
Passive deficit = tax rate x
(potential output – actual output)
Structural deficit = actual deficit – passive
deficit
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31-9
Nominal and Real
Surpluses and Deficits
• A nominal deficit is the difference between
•
•
•
expenditures and receipts.
A real deficit is the nominal deficit adjusted for
inflation.
Inflation reduces the value of the debt.
Real deficit = Nominal deficit –
(Inflation x Total debt)
Lowering the real deficit by inflation can be
costly because it may build inflation into
expectations and cause higher interest rates.
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31-10
The Definition of Debt and Assets
• Debt is accumulated deficits minus
•
•
•
accumulated surpluses.
Debt is a stock, defined at a point in
time.
Deficits and surpluses are flow
concepts, defined for a period of time.
The U.S. Treasury must sell new bonds
to pay for a deficit and refinance
previously issued bonds as they come
due.
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31-11
Social Security and the U.S. Deficit
• Since debt is accumulated deficits, the
•
•
change in debt each year should be the
size of the surplus or deficit.
The deficit that the government reports is
on the unified budget, which includes offbudget and-budget accounts.
The debt reported is on the on-budget
accounts only.
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31-12
The Need to Judge Debt
Relative to Assets
• Debt, as a summary measure of a
•
•
nation’s financial situation, needs to be
judged in relation to a nation’s assets.
When the government runs a deficit, it
might be spending on projects that
increase its assets.
If the assets are valued at more than their
costs, then the deficit is making society
better off.
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31-13
Ownership of the Debt
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31-14
Differences Between Individual
and Government Debt
• Government debt is ongoing, but individual
debt must eventually be repaid.
• Government, but not individuals, can print
money to pay off debt.
• Most of the government’s debt is internal debt
– debt owed to its agencies or to its citizens.
 External debt – owed to individuals in foreign
countries – is more like individual debt.
• Paying interest on internal debt redistributes
income, but does not cause a net reduction in
income of the average citizen.
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31-15
Budget Deficits as a
Percentage of GDP
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31-16
Debt as a Percentage of GDP
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31-17
U.S. Debt Compared to
Foreign Countries’ Debt
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31-18
Federal Interest Payments
Relative to GDP
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31-19
Projections for the Budget Deficit
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31-20
Social Security and Lockboxes
• Because the government uses a cash flow
•
•
accounting system, which enters expenses
and revenues only when cash is received or
paid out, many government obligations do not
show up as part of expenditures.
The Social Security system currently has a
large surplus.
Some politicians advocate the creation of a
“lockbox” to protect the surplus for future
retirees.
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31-21
Pay-as-You-Go System
• The Social Security system was set up as
•
a pay-as-you-go system, in which
payments to current beneficiaries are
funded through current payroll taxes.
An unfunded pension system works
smoothly as long as the population’s age
distribution, the annual death rate, and
the number of people working do not
change much.
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31-22
Projection of Workers
Compared to Retirees
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31-23
The Social Security Trust Fund
• In 1983 legislation was passed to aid Social
Security:
 It raised the age of eligibility slightly.
 Social Security tax rates were increased.
 Social Security payments became subject to
taxation for some beneficiaries.
• The portion of surpluses held by Social
Security is not available for spending – it is
saved for the trust fund.
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31-24
The Real Problem
Price level
LAS
SAS1
C
B
SAS0
A
AD1
AD0
Real output
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31-25
Politically Unpopular Policies
• The Social Security problem can be solved by:
 Increasing taxes in 2020 on those working.
 Cutting benefits once baby boomers start retiring.
 Making Social Security means tested.
 Increasing the retirement age to 72.
• The proposal to privatize Social Security will
not solve the problem because if people leave
the system and move to private accounts, there
will be even less money available to pay
current benefits and the government will have
to borrow the shortfall.
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Summary
• A deficit is a shortfall of revenues over
•
payments. A surplus is an excess of revenues
over payments. Debt is accumulated deficits
minus accumulated surpluses.
Deficits and surpluses are summary measures
of a budget. Whether a budget is a problem
depends on the budgeting procedures that
measure it.
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31-27
Summary
• A passive deficit is the part of the deficit that
•
•
•
•
exists because the economy is below its
potential.
A structural deficit is that part of a budget
deficit that would exist even if the economy
were at its potential income.
Structural deficit = Actual deficit –
Passive deficit
A real deficit is a nominal deficit adjusted for
inflation.
Real deficit = Nominal deficit – (InflationxDebt)
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31-28
Summary
•
Government debt and individual debt differ in three
major ways:



•
Government is ongoing and never needs to repay its debt.
Government can pay off its debt by printing money.
Most of the government debt is internal – owed to its own
citizens – so interest payments go to U.S. citizens.
Deficits, surpluses, and debt should be viewed relative
to GDP because this ratio better measures the
government’s ability to handle the deficit and pay off
the debt.
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31-29
Summary
• The Economic Growth and Tax Relief
•
•
Reconciliation Act of 2001, an economic
slowdown, and the war on terrorism
contributed to a return to budget deficits in
2002.
Beginning in 2020, the Social Security system
will run deficits.
The real problem is not the solvency of the
Social Security system but the future mismatch
between real production and real expenditures.
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31-30
Review Question 31-1 Distinguish between a structural deficit and a
passive deficit.
A structural deficit is the part of the budget deficit that would exist
even if the economy were at its potential level of income. A passive
deficit is the part of the deficit that exists because the economy is
below potential.
Review Question 31-2 What are some of the possible solutions to
the problem of Social Security solvency?
Increase taxes on those working in 2020. Cut benefits to baby
boomers when they retire. Make Social Security means tested.
Increase the retirement age to 72.
Privatization will not solve the solvency problem because Social
Security is a partially unfunded pension system. Funds diverted to
private accounts would not be available to pay as benefits to current
retirees.
McGraw-Hill/Irwin
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.