DEFICIT VS. DEBT FLOW VS. STOCK

Chapter 15 part 3

Defining 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

Debt is a stock, defined at a point in time

DebtDebtDebt is accumulated deficits minus

accumulated surpluses• Debt is a stock, defined at a point in time

Debt = Accumulated Deficits + Accumulated Surpluses

•Deficit Increases the Debt

• Surpluses Reduce the Debt

• If a country has more surpluses than deficits, the accumulated surpluses minus accumulated deficits are a part of its assets

Defining Surpluses and Debt

• A surplus is an excess of revenues over payments.• A deficit is a shortfall of revenues

over payments.

The Definition of Debt and Assets

• Debt is accumulated deficits minus accumulated surpluses.• Deficits and surpluses are flow

concepts.• Debt is a stock concept.

Long-Run Implications

U.S. government budget accounting is calculated on the basis of fiscal years.

Persistent budget deficits have long-run consequences because they lead to an increase in public debt.

A String of Deficits

1970 1994 1996 1998 2000 200219721974 19761978 1980 198219841986 198819901992

Budget Surpluses

Budget Deficits

The U.S. Government Has Always Been in Debt Except

• 1835-36: Debt Free! – The U.S. was completely out of debt by 1835.

• The Mexican-American War (1846-48) caused a four-fold increase in the debt

The Public Debt

• Differentiating between the Deficit and the Debt– The deficit occurs when federal government spending is

greater than tax revenue– The debt is the cumulative total of all the federal budget

deficits less any surpluses• Suppose that our deficit declined one year from $200 billion to

$150 billion• The national debt would still go up by $150 billion• So every year that we have a deficit – even a declining one –

the national debt will go up

12-48Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

The Public Debt

12-49Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000

5

4

3

2

1

0

6

National Debt, 1975-2000

Economic Report of the President, 2000

How it works?

• The U.S. Treasury must sell new bonds to pay for a deficit and refinance previously issued bonds as they come due

Debt Management

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

Debt

Federal Reserve (9%)

© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

Foreign individuals and firms (25%)

U.S. individuals and firms (24%)

U.S. government agencies (42%)

Ownership of the DebtOther U.S.

governmenttrust funds,

12%

Social Securitytrust fund, 18%

FederalReserve, 11%

In 2012

Difference Between Individual and Government Debt1. The government lives forever; people don’t

2. The government can print money to pay its debt; people can’t

3. Government owes much of its debt to itself (to its own citizens)

• Internal debt is government debt owed to other governmental agencies or to its own citizens

• External debt is government debt owed to individuals in foreign countries

Difference Between Individual and Government Debt

•Internal debt is government debt owed to other governmental agencies or to its own citizens•External debt is government debt owed to individuals in foreign countries

External Debt is more like individual debt

External Debt is more like individual debt

U.S. Budget Deficits as Percentage of GDP

Deficits as percentage of GDP

1900 1920 1940 1960 1980 2000 2020

10

0

-10

-20

-30

Deficits and debt relative to GDP provide measures of a country’s ability to pay off a deficit and service its debt

U.S. Debt as Percentage of GDPDebt as Percentage of GDP

1800 1840 1880 1920 1960 2000 ‘20

100

75

50

25

Ignore the Ignore the Absolute Figure Absolute Figure when it comes when it comes to Deficit and to Deficit and Debt!Debt!

Measure Deficit and Debt as a Percentage of GDP!

Debt / GDP = Debt / GDP = Debt to GDP RatioDebt to GDP Ratio

READ THE SECTION ON THE DEBT BURDEN

82%82%80%

68%52%

42%

37%23%

U.S. Debt Compared to Foreign Debt

Debt as a Percentage of GDP

The U.S. debt does not appear so large when

compared to the debts of some other countries in

the early 2000s

Federal Interest Payments Relative to GDP

Interest payments as percentage of GDP

1945 1955 1965 1975 1985 1995 2005 2015

3.5

3.0

2.5

2.0

1.5

1.0

0.5

High interest rates and large increases

in debt

Interest rates fell and surpluses reduced the

total debt

Chapter Summary

A deficit is a shortfall of revenues under payments

A surplus is the excess of revenues over payments

Debt is accumulated deficits minus accumulated surpluses

Deficits and surpluses are summary measures of a budget

A cyclical deficit is that part of the deficit that exists because the economy is below or above potential output

A structural deficit is that part of a budget deficit that would exist even if the economy were at its potential level of output

Chapter Summary

A real deficit is a nominal deficit adjusted for the effect of inflation

A country’s debt must be judged in relation to its assets

Government debt and individual debt differ

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

Since 2008, the U.S. has run significant deficits and the debt-to-GDP ratio has risen to over 100 percent