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BUDGET BALANCE AND GOVERNMENT DEBT
C h a p t e r 12
Federal Budget Balance
Borrowing is an alternative to current taxation as a means of financing government expenditures.
Budget deficit is excess of government outlays over receipts taken in taxes, fees, and charges levied by government authorities.
Budget surplus is excess of government receipts over outlays.
Federal budget balance as a percentage of GDP has been negative, signifying a budget deficit, in most years over the period 1962–2005.
Federal Budget Balance
High-Employment Deficit or Surplus
A calculation that estimates the budget deficit or surplus that would prevail at a certain designated level of unemployment in the economy
Government expenditures raise as unemployment rates go up
Tax revenues increase with increase in employment
Standardized level of employment usually set between 5% and 6%
Receipts and expenditures adjusted accordingly to reflect their levels if 94% to 95% of those in the labor force were actually employed
Measuring the Budget Balance
Unified budget balance is the difference between all federal government expenditures and revenues, “on budget” or “off budget”.
Main “off budget” operations – Social Security, postal service
NIPA budget balance is official measure of federal deficit in the National Income and Product Accounts.
Does not include transactions that finance preexisting debts, such as outlays for deposit insurance
Real budget balance is a measure of change in federal debt after adjustment for effects of inflation and changing interest rates on the real market value of the outstanding net debt.
Deficit and Political Equilibrium
By borrowing rather than using taxes to finance government activities, politicians can influence willingness of voters to vote for increased spending.
Deficits can affect resource allocation and overall size of government in the economy.
Borrowing postpones burden of taxation, so often used to finance investments that will provide a stream of future benefits.
Often used to finance wars, military technology
Surpluses can be used to finance new government spending or tax rate reductions.
Deficit Effect on Credit Markets
Traditional view holds that deficit contributes to higher interest rates.
Can choke off private investment, slowing real rate of economic growth
Borrowing by households to finance durable goods such as cars and homes
Higher interest rates encourage more saving, decreasing private consumption
Ricardian equivalence is when an increase in government borrowing to finance deficit causes increase in private saving that keeps level of interest rates fixed.
Deficit Effect on Credit Markets
Ricardian Equivalence
Surplus Effect on Credit Markets
Balanced budget or surplus implies that market demand for credit is equal to private demand for credit
However, government can affect supply of loanable funds available for private investment in credit markets
If surplus used for tax reduction, it supplies funds to consumers as well as investors
If result with consumers is consumption instead of saving, no increase in supply of loanable funds, no decline in real interest rates
Surplus Effect on Credit Markets
National Saving
The more we save today, the greater our future rate of growth output; the less we save, the smaller our future potential to grow.
National saving is the sum of personal saving by households, business saving, and saving by the government sector.
For government to help increase national saving, it must run a surplus
Net contribution of government to national saving is combined deficit/surplus of federal government and all state and local governments.
Reduced supply of savings can contribute to higher real interest rates and lower economic growth.
National Saving
Net Federal Debt
Net Federal debt – that portion of the debt of the federal government held by the general public, excluding holdings of U.S. government agencies, trust funds, Federal Reserve banks
Internal debt – portion of a government’s indebtedness owed to its citizens
External debt – portion of a government’s debt borrowed from abroad
Net Federal Debt
Ownership of the Federal Debt
Ownership of the Federal Debt
State and Local Government Debt
Much of the holdings of debt likely to be external debt, or held by those not residing in that jurisdiction
Undue reliance on debt finance can redistribute future income away from residents, as tax revenues used to pay creditors in other jurisdictions
Use two broad types of securities to cover debt:
General obligation bonds, backed by taxing power of government issuing securities
Revenue bonds, backed by promise of revenue to be earned on the facility being financed by the bonds
Burden of the Debt
The redistributive effect of debt financing
Compared with tax financing, debt financing allows current generation more private consumption opportunities over its lifetime
But to pay interest and return principal on the debt, government usually increases taxes; future taxpayers undergo reductions in consumption, saving
Future generations also suffer reduction in living standards if past deficits cause interest rates to rise, reduce private investment
Burden of debt can be offset if revenue obtained from public debt used to finance projects that yield future benefits

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