AP Econ Module 30 Deficits Debt - Sunny Hills High School

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A liscal yoat runs from october 1 to September 30 and is labeled according to the calendaryear in which it ends. Public debt is government debt held by indivlduals and institutions outside the govemment. 300 section 6 Nonetheless, policy makers concerned about excessive deficits sometimes feel that rigid rules prohibicing-or at leasr setting an upper limit on_deficits afe necessary. Long-Run lmplications of Fiscal policy During the 1990s, the Japanese governmenr engaged in massive deficit spend.ing in an effort. to increase aggregate demand. That policy was partly successful altiough Japan's economy was sluggish during the l99Os, it avoided a s"r,e.e slump comparabie ro what happened to many countries in the 1930s. yet the fact rhatJapan was running large deficits year after year made many observers uneasy, as Japan,s d.ebt_the accumui lationofpast deficits, net ofsurpluses-climbed to alarmingievels. Now that we under_ stand how governmenr surpluses and deficits happen, leCi take a closer look at their long-run effects on the economy. Deficits, Surpluses, and Debt 'rVhen a family spends more than it earns over rhe cours e of tyear, it has to raise the exrra funds either by selling assets or by borrowing. And ifa family borrows year after year, ir will evennrally end up with a lot of debt. The same is true for governments. With a few exceptions, governments don,t raise large sums by selling assets such as national parkland. Instead, when a governmenr spends more tharr the tax revenue it receives-when it runs a budget deficit_it almost always borrows the extra funds, And governmenrs that run persiitent budget deficits end up with substantial debts. , To interprer the numbers thar follow, you need ro know a slightly peculiar feature of federal government accounting. For historical reasons, the U.S. government does not keep the books by calendar years. Instead, budget totals are kepi by fiscal years, which run from October 1 to September 30 and are labeled by the calendar year in which they end. For example, fiscal2009 began on October 1,200g, and ended on September 30,2009. At the end of fisca.l 2009, the U.S. federal governmenr had total debt equal to $12 trillion. However, pan ofrhat debr represented special accounting rules spe.i$ring that the federal government as a whole owes funds to certain gor,"--"rra p-gr*., cially Social Security. We,ll expla.in those rules shortly. For now, however, leCs focus "rp"_ on public debe government debt held by individuals and institurions outside the government. At the end of fiscal 2009, the federal governmenCs public debt was..only', $7.6 trillion, or 53% ofGDP If we include the debts of state and local governments, total government public debt was approximately 69% ofGDP. U.S. federal government public debt at the end offiscal 2009 was larger than ir was at the end offiscal 2008 because the federal government ran a budget deficir during fiscal 2OO9. A government that runs persistent budget deficits will experience a rising level ofdebt.'&/hy is this a problem? Problems Posed by Rising Government Debt There are two realsons to be concerned when a government runs persistent budget deficits. We described one reason previously: when the government borrows funds in the financial markets, it is cornpeting wirh firms that plan to borrow funds for investment spending. As a result, the government's borrowing may ,.crowd out', private investment spending, increasing interest rates and reducing the economy's long-run rate ofgrowth. The second reason: today's deficits, by increasing the govemmenCs debt, place financial pressure on future budgets. The impact ofcurrent deficits on future budgets is straightforward. Like individuals, govemments musr pay their bills, including inierest payments on their accumulated debr. V/hen a governmenr is deeply in debg those in_ terest payments can be substaltial. In fiscal 2009, the U.S. federal government paid lnflalion, Unemployment, and Stabilization policies
2.7yo of GDP-9383 billion-in interest on its debt. And although this is a relatively large fraction ofGDP, other countries p ay even greater frartions oftheir GDp to service their debt. For example, in 2009, Greece paid interest ofabout S.4% ofcDp. Other things equal, a govemment paying Large sums in interest must raise more revenue from taxes or spend less than it would otherwise be able to afford-or it must borrow even more to cover the gap. And a government that borrows to pay interesr on irs outstanding debt pushes itselfeven deeper into debt. This process can evenrually push a govemment to the point at which lenders question its abfiry to repay. Like consumers who have maxed out their credit cards, the govemnent will find that lenders are unwilling to lend any more funds. The result can be thar rhe government defaults on its debt-it srops pafng what it owes. Default is often followed by deep financial and economic turmoil. The idea of a government defaulring sounds far-fetched, but it is not impossible. In the 1990s, Argentina, a relatively high-income developing country was widely praised for its econornic policies-and it was able to borrow large sums from foreign lenders. By 2001, however, Argentina's interest payments were spiraling out ofcontrol and the country stopped paying the sums that were due. Default creates havoc in a country's financial markets and badly shakes public confidence in both the government and the economy, Argentina's debt default was accompaaied by a crisis in the country's banking system and a very severe recession. And even if a highly indebted govemment avoids default, a heavy debt burden typically forces it to slash spending or raise taxes, politically unpopular measures that can also damage the econorny. One question some people ask is: can't a govemment that has t(ouble borrowing just print money to pay irs bills? Yes, it can, but this leads to another problem: inflation. In fart, budget problems are the main cause ofvery severe inflacion, as we'Il see later. The point for now is that governments do not want to find themselves in a position where the choice is between defaulting on their debts and inflating those debts away. Concerns about the long-run effects of deficits need not rule out the use of fiscal polici' to stimulate the economy when it is depressed. However, these concems do mean that governments should try to offset budget deficits in bad years with budget surpluses in good years. In other words, governments should run a budget that is approxirnately balanced over time. Have they actually done so? Deficits and Debt in Practice Figure 30.4 on the next page shows how the U.S. federal govemmenc's budget deficit and its debt have evolved since 1940. Panel (a) shows the federal deficir as a percentage of GDP. As you can see, the federal govemment ran huge deficits during World W'ar II. It briefly ran surpluses after the war, but it has normally run deficits ever since, especially after 1980. This seems inconsistent with the advice that governments should offset deficits in bad times with surpluses in good times. However, panel (b) ofFigure 30.4 shows that these deficits have not led to runaway debt. To assess the ability of governments to pay their debr, we often use the debt- GDP ratio, the governmenCs debt as a percentage ofGDP. W'e use this measure, raaher than simply looking at the size ofthe debt because GDP, which measures the size ofthe economy as a whole, is a good indicator oFthe potential taxes the government cal collect. Ifthe governmenCs debt grows more slowly than GDP, the burden ofpafng that debt is actua-lly fa-lling compared with the governmenCs porential rax revenue. What we see from panel (b) is that although the federal debt has grown in almost eyery year, the debt-cDP ratio fell for 30 years after the end of World War II. This shows that the debt-GDP ratio can fall, even when debr is rising, as long as GDP grows faster than debt. Growth and inflation sometimes allow a govemment that runs persistent budget deficits to nevertheless have a declining debt-GDP rado. m o d u le 3 0 Long-run lmplications of Fiscal Policy: Deficits Lautario Palacios, T, holds a sign that calls forpotiticlans to stop robblng, durlng a January 9, 2oo2 demonstlatlon ln Buenos Aires, Argentina. fte debt-G0P ratio is he government's debt as a percentage of GDP, and the Public Dsbl 301
Page 1 and 2: Module 30 Long-run lmplications of
Page 3 and 4: where Iis the yalue of ta-r revenue
Page 5: The Actual Budget Deficit Versus th
Page 9 and 10: What Happened to the Debt from Worl
Page 11 and 12: ffiffirywffimk Argentina's Creditor

AP Econ Module 30 Deficits Debt - Sunny Hills High School

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