ECONOMICS TOPIC 9 LESSON 3

ECONOMICS TOPIC 9 LESSON 3

The National Debt and Deficits

ESSENTIAL QUESTION

What is the proper role of government in the economy?

OBJECTIVES

•Explain the importance of balancing the budget.

•Analyze the impact of fiscal policy decisions on the nation’s economy.

•Summarize the way budget deficits add to the national debt.

Identify how political leaders have tried to control the deficit

Budget Surpluses and Deficits

The basic tool of fiscal policy is the federal budget. It is made up of two fundamental parts: revenue (taxes) and expenditures (spending programs). When the federal government’s revenues equal its expenditures in any particular fiscal year, the federal government has a balanced budget.

Budget Surpluses and Deficits

A budget surplus occurs in any year when revenues exceed expenditures.

A budget deficit occurs in any year when expenditures exceed revenues.

Dealing with Deficits

When the government runs a deficit, it is because it did not take in enough revenue to cover its expenses for the year. When this happens, the government must find a way to pay for the extra expenditures. There are two basic actions the government can take to do so.

Dealing with Deficits

Creating Money

The government can create new money to pay salaries for its workers and benefits for citizens. Traditionally, governments simply printed the bills they needed. 

Dealing with Deficits

Creating Money

This approach works for relatively small deficits but can cause severe problems when there are large deficits. What are these problems?

Dealing with Deficits

Creating Money

When the government creates more money, it increases the amount of money in circulation. This increases the demand for goods and services and can increase output. This can lead to runaway inflation.

Dealing with Deficits

Borrowing Money

The U.S. federal government usually does not resort to creating money to cover a budget deficit. Instead, it borrows money. 

Dealing with Deficits

Borrowing Money

The government commonly borrows money by selling bonds. A bond is a type of loan: a promise to repay money in the future, with interest. Consumers and businesses buy bonds from the government. The government thus has the money to cover its budget deficit. In return, the purchasers of the bonds earn interest on their investment over time.

Open Ended

Budgets that followed the gray horizontal line on this graph would be balanced. Analyze Graphs Write a brief summary of this graph and the story it tells about surpluses and deficits from 1950 to 2012.

Multiple Choice

Recall What is the most common method the federal government uses to pay for expenditures that exceed revenues?

• It spends more.

• It borrows more.

• It creates money.

• It lowers taxes.

Deficits and the National Debt

The national debt is the total amount of money the federal government owes to bondholders. Every year that there is a budget deficit and the federal government borrows money to cover it, the national debt will grow.

The Difference Between Deficit and Debt

The deficit is the amount of money the government borrows for one budget, representing one fiscal year. The debt, on the other hand, is the sum of all the government borrowing before that time, minus the borrowings that have been repaid.

Measuring the National Debt

In dollar terms, the size of the national debt is extremely large. By the end of 2013, it exceeded $17 trillion! Such a large number can best be analyzed in relation to the size of the economy as a whole. Therefore, let’s look at the size of the debt as a percentage of gross domestic product (GDP) over time.

Multiple Choice

Check Understanding To whom does the government owe the national debt?

• to the general public

• to government officials

• to the Treasury Department

• to investors who hold government bonds

The Impact of Debt

The first problem with a national debt is that it reduces the funds available for businesses to invest. This is because in order to sell its bonds, the government must offer a higher interest rate.

The Impact of Debt

This loss of funds for private investment caused by government borrowing is called the crowding-out effect.

The Impact of Debt

The second problem with a high national debt is that the government must pay interest to bondholders. The more the government borrows, the more interest it has to pay. Paying the interest on the debt is sometimes called servicing the debt.

The Impact of Debt

A possible third problem involves foreign ownership of the national debt. The biggest holder of that debt is the United States government itself. The government uses bonds as a secure savings account for holding Social Security, Medicare, and other funds. But about a quarter of the debt is owned by foreign governments, including Japan, China, and the United Kingdom. 

Open Ended

On the subject of the national debt, observers differ over the nature and extent of the threat. Compare Points of View Explain how these two viewpoints differ on the subject of the national debt.

Multiple Choice

Identify The dangers associated with having a large national debt are

• runaway hyperinflation, overheated growth, and low productivity.

• the crowding-out effect, high interest payments, and the influence of foreign debt-holders.

• the crowding-out effect, unbalanced budgets, and careless money creation.

• budget surpluses, deficit spending, and sluggish bond sales.

Measures to Control the Deficit

Reducing Deficits

Concerns about the budget deficits of the mid-1980s caused Congress to pass the Gramm-Rudman-Hollings Act. This law created automatic across-the-board cuts in federal expenditures if the deficit exceeded a certain amount. 

Measures to Control the Deficit

Reducing Deficits

The 1990 Budget Enforcement Act created a “pay-as-you-go” system (also known as PAYGO). PAYGO required Congress to raise enough revenue to cover increases in direct spending that would otherwise contribute to the budget deficit. This law expired in 2002, but in 2007 the House and Senate restored PAYGO in the form of special budget rules. 

Measures to Control the Deficit

The Surpluses of the Late 1990s

The late 1990s brought a welcome reversal of fortune. For the first time in thirty years, the President and the Office of Management and Budget were able to announce that the federal government was running a surplus.

Measures to Control the Deficit

A Return to Deficit Spending

The changeover from deficits to surplus brought with it a different set of political concerns. Investors who had come to rely heavily upon Treasury bonds as the basic “safe” investment worried that the federal government would remove all bonds from the market as it repaid its debt.

Measures to Control the Deficit

A Return to Deficit Spending

However, the surplus was short-lived. The end of the stock market boom, an economic slowdown, and a new federal income tax cut reduced federal revenues. 

Multiple Choice

Identify Which of the following factors contributed to the deficit spending of the 2000s?

• a booming economy

• a federal income tax increase

• increased spending on defense

• the sale of government bonds to foreign investors

Open Ended

What is the proper role of government in the economy?