Federal Budget Deficit Economics
Economics for Strategic Decisions
U.S. Federal Budget Deficit
Introduction and History
The U.S. Federal Budget deficit is the fiscal year difference between what the United States Government takes in from taxes and other revenues, called receipts, and the amount of money the government spends, called outlays. The items included in the deficit are considered either on budget or off budget. Generally, on-budget outlays tend to exceed on-budget receipts, while off-budget receipts tend to exceed off-budget outlays. The United States public debt, commonly called the national debt, gross federal debt or U.S. government debt, grows as the U.S. Federal Budget remains in deficit and is the amount of money owed by the United States government …show more content…
to creditors who hold US securities like T-bills, notes and bonds. This does not include the money owed by states, corporations, or individuals, nor does it include the money owed to Social Security beneficiaries in the future.
As of April 18th, 2006, the total U.S. government debt was $8.395724 trillion. The United States has had public debt since its inception. Debts incurred during the American Revolutionary War and under the Articles of Confederation led to the first yearly reported value of $75,463,476.52 on January 1, 1791. Over the following 45 years, the debt grew and then contracted to nearly zero in late 1834. On January 1, 1835, the national debt was only $33,733.05, but it quickly grew into the millions again. The first dramatic growth spurt of the debt occurred because of the Civil War. The debt was just $65 million dollars in 1860, but passed $1 billion in 1863 and had reached $2.7 billion following the war. The debt slowly fluctuated for the rest of the century, finally growing steadily in the 1910s and early 1920s to roughly $22 billion as the country paid for involvement in World War I. The buildup and involvement in World War II brought the debt up another order of magnitude from $43 billion in 1940 to $260 billion following the war. After this period, the debt's growth closely matched the rate of inflation until the 1980s, when it again began to skyrocket. The public debt briefly started to go down in 2000 …show more content…
when the country had a substantial budget surplus, but began growing again after budget deficits grew large beginning in 2002.
At any given time, at least in recent decades, there is a debt ceiling in effect. If the debt grows to this ceiling level, many branches of government are shut down or only provide extremely limited service. However, the ceiling is routinely raised by passage of new laws by the United States Congress every year or so. The most recent example of this occurred in March of 2006, when the U.S. Congress agreed to raise the National Debt Ceiling to just under $9.000 trillion. Viewed alternately as a percentage of the GDP, the national debt rose sharply during World War II, reaching about 122% of GDP in 1946. As soon as the conflict ended, the debt began declining, reaching a postwar low of 32.6% of GDP in 1981. The debt then started rising again and peaked at 67.3% of GDP in 1996. It then dropped to 57.4% of GDP by 2001. The debt of the United States is on par with the debt of other developed countries, such as Germany and France.
Causes Opinions on the causes of the U.S. Federal Budget deficit vary greatly. The three that I have chosen to highlight are a decrease in the private saving rates of Americans, productivity growth and a slump in foreign domestic demand. Proponents of a decline in saving rate are also mainly supporters of the belief in American over-indulgence. Since the mid-1990s, the personal saving rate has declined from roughly 5 percent of disposable income to less than 2 percent, and gross private saving (which includes corporate saving) has edged down from about 16 percent of GDP to less than 15 percent. The decline in saving rates could reflect a structural shift in household saving and spending behavior. Continued financial liberalization and innovation have made it easier for Americans to borrow, particularly against their real estate wealth, and this easing may have led to greater consumption. An impressive achievement of the U.S. economy which has contributed to its skyrocketing budget deficit is the surge in labor productivity growth from about 1-1/2 percent annually in the two decades preceding 1995 to roughly 3 percent in the period since then. This surge is viewed as having several important consequences. First, higher productivity growth boosted perceived rates of return on U.S. investments, thereby generating capital inflows that boosted the dollar. Second, these higher rates of return also led to a rise in domestic investment. Finally, expectations of higher returns boosted equity prices, household wealth, and perceived long-run income, and so consumption rose and saving rates declined. Under this explanation, all of these factors helped to widen the current account deficit. Lastly, domestic demand growth has slumped in many foreign economies because of varying combinations of an increase in saving rates and a decline in investment. This weakening of foreign spending has enhanced the supply of capital available to the United States, put downward pressure on U.S. interest rates, and put upward pressure on the dollar. Some of the largest industrial economies in the world, Japan and Western Europe, have been running current account surpluses while experiencing very subdued growth. In the developing world, the East Asian economies that went through financial crises in the late 1990s have seen a plunge in their investment rates even as their saving rates have remained extremely high; the weakness in domestic demand has likely motivated the authorities in these countries to keep their exchange rates competitive to promote export-led growth, a strategy that has also contributed to the U.S. deficit. In general, since 1999, the developing countries as a whole have been running current account surpluses, with the industrial countries, mainly the United States, necessarily running current account deficits.
The federal budget and the economy are closely interrelated. The strength or weakness of the overall economy affects the levels of outlays and receipts substantially. The budget also has significant effects on the economy, both in terms of how fast the economy grows, and also in terms of the overall allocation of resources. Short-Term Implications
Over fairly short periods of time, say three or four years, fiscal policy can affect the rate of economic growth by adding to, or subtracting from, aggregate demand. Consider, for example, a one-time increase in total federal spending, with no matching rise in tax receipts. Each additional dollar of government spending becomes income for those who satisfy the initial increase in demand for public goods and services. In turn some of that increase in income will be spent, raising the income of those who satisfy a second wave of increased demand for goods and services. Theoretically, this process continues with each successive increment to income getting smaller and smaller as some is saved and some is spent.
Due to the initial increase in spending and the additional spending that is subsequently stimulated, the economy grows somewhat faster than it otherwise would have. For a time, the size of the economy may even increase by more than the initial increase in government spending. Government spending is thus said to have a "multiplier effect."
There can also be a multiplier effect in the case of a spending cut, although the effect is in the opposite direction. If the government reduces spending, that can cut the incomes of those who otherwise would have provided goods and services to the government. If it does, they must either reduce their spending or their saving. To the extent that they cut spending, it adds to the decline in output initiated by the cut in public spending.
The government may also be able to influence the rate of economic growth in the short run via tax cuts or increases. Just as an increase in public sector spending temporarily increases some incomes, so a tax cut increases the amount of income taxpayers have at their disposal. Some of that increase in after tax income is likely to be spent, and so tax cuts may have a multiplier effect just as changes in government spending do. A tax increase reduces disposable income, and so contributes to a slowdown in private sector spending. In the view of most economists, the government cannot permanently increase the size of the economy just by increasing spending, or cutting taxes. As is often the case in economics, other things do not remain equal. An increase in spending, or a tax cut, increases the deficit and so increases the public sector's demand for credit. Increased credit demand tends to raise interest rates. Higher interest rates, in turn, discourage borrowing in the rest of the economy for those activities that depend on credit, especially housing and consumer durable goods.
Higher interest rates also tend to make dollar-denominated financial assets more attractive to overseas investors. In order to buy those assets, however, foreigners must first buy dollars. This increased demand for dollars pushes the foreign exchange value of the dollar above what it otherwise would have been. The "stronger" dollar makes imported goods cheaper, and makes goods and services produced in the United States more expensive abroad. The change in prices tends to increase demand for U.S. imports and reduce demand abroad for U.S. exports, raising the trade, or current budget deficit.
Long-Term Implications A constant deficit or surplus, by itself, is believed to have little if any effect on the short run rate of economic growth. It is changes in the surplus that matter for short run growth. However, whether the budget is in surplus or not does have consequences for the composition of economic output, and that can have an effect on growth in the long run.
In the long run, economic growth is determined primarily by three factors; growth in the labor force, the rate of technological advance, and the amount of capital available to the workforce.
Of the three, the last one may be the most susceptible to the influence of policymakers. The larger the capital stock, the more productive the labor force tends to be.
While it may be possible for fiscal policy to have an effect on the rate of technological progress in the way public money is spent, it probably has a much larger effect on growth through its influence on the size of the domestic stock of capital and the amount of capital available to each worker in the labor force. The total value of national output can be measured in two ways. Either the total value of the goods and services produced can be added up, or the total value of the incomes resulting from that production can be counted.
The measure of total output based on the value of production is typically subdivided into several categories of demand. Specifically, it is calculated as the sum of consumption spending (C), investment (I), government spending (G) and the difference between exports (X) and imports (M):
GDP = C + I + G + (X - M) The alternative measure of total output is the sum of the various uses to
which income is allocated. On this side of the economic accounting ledger the value of national output is expressed as the sum of consumption (C), private sector saving (S), and tax payments (T):
GDP = C + S + T
Combining the two equations, and simplifying gives:
I = S + (T - G) + (M - X)
Total investment spending is equal to the sum of private saving (S), the government budget surplus (T - G, which, if it is negative, is a deficit), and the difference between imports and exports of goods and services (M - X). Therefore investment is by definition equal to the sum of private saving, the budget surplus, and net capital inflows from abroad. Other things being equal, a reduction in public sector saving means less investment and slower growth in the capital stock.
Reducing the Federal Debt
Perhaps the most obvious effect of the federal government budget surpluses of the 1990s was a decline in the amount of federal debt. From an economic perspective, however, the measure of debt that matters more is not the absolute level in dollar terms, but rather the debt relative to total output, or GDP. From this perspective, the debt began to fall in 1993.
Many economists believe that a steadily growing federal debt is not by itself a cause for concern. As long as the federal debt grows faster than GDP, however, interest payments on that debt will constitute an ever-increasing share of total federal spending and of GDP. If investors should come to expect that the debt would grow faster then GDP indefinitely, and that the debt-to-GDP ratio would continue to rise, they might eventually become unwilling to buy new issues of federal debt.
In the long run, the relationship between the growth rate of the federal debt and the overall rate of economic growth is critical to financial stability. Perpetual growth in the debt in excess of the rate of economic growth is an inherently unstable situation. It is likely that investors would become unwilling to buy federal debt issues long before all of GDP was accounted for by the interest payment on the federal debt, because of growing doubts about the government's ability to raise sufficient revenue to pay the interest on that debt.
Thus even with a budget deficit, the ratio of debt to national income can fall.
For the United States, the recent peak level of the federal debt relative to GDP was reached in 1993 at 49.4%, when the budget deficit was $255 billion. In 1994, even though the deficit was still over $200 billion, the debt fell relative to GDP. By 2001, federal debt had fallen to a low of 33.0% of GDP. In 2002, the ratio of debt to GDP began to rise for the first time in eight years, and in 2004 stood at 37.2%.
http://www.publicdebt.treas.gov/opd/opdfaq.htm#opdfaq12 http://www.publicdebt.treas.gov/opd/opdhisto4.htm
U.S. Federal Budget Deficit
Introduction and History
The U.S. Federal Budget deficit is the fiscal year difference between what the United States Government takes in from taxes and other revenues, called receipts, and the amount of money the government spends, called outlays. The items included in the deficit are considered either on budget or off budget. Generally, on-budget outlays tend to exceed on-budget receipts, while off-budget receipts tend to exceed off-budget outlays. The United States public debt, commonly called the national debt, gross federal debt or U.S. government debt, grows as the U.S. Federal Budget remains in deficit and is the amount of money owed by the United States government …show more content…
to creditors who hold US securities like T-bills, notes and bonds. This does not include the money owed by states, corporations, or individuals, nor does it include the money owed to Social Security beneficiaries in the future.
As of April 18th, 2006, the total U.S. government debt was $8.395724 trillion. The United States has had public debt since its inception. Debts incurred during the American Revolutionary War and under the Articles of Confederation led to the first yearly reported value of $75,463,476.52 on January 1, 1791. Over the following 45 years, the debt grew and then contracted to nearly zero in late 1834. On January 1, 1835, the national debt was only $33,733.05, but it quickly grew into the millions again. The first dramatic growth spurt of the debt occurred because of the Civil War. The debt was just $65 million dollars in 1860, but passed $1 billion in 1863 and had reached $2.7 billion following the war. The debt slowly fluctuated for the rest of the century, finally growing steadily in the 1910s and early 1920s to roughly $22 billion as the country paid for involvement in World War I. The buildup and involvement in World War II brought the debt up another order of magnitude from $43 billion in 1940 to $260 billion following the war. After this period, the debt's growth closely matched the rate of inflation until the 1980s, when it again began to skyrocket. The public debt briefly started to go down in 2000 …show more content…
when the country had a substantial budget surplus, but began growing again after budget deficits grew large beginning in 2002.
At any given time, at least in recent decades, there is a debt ceiling in effect. If the debt grows to this ceiling level, many branches of government are shut down or only provide extremely limited service. However, the ceiling is routinely raised by passage of new laws by the United States Congress every year or so. The most recent example of this occurred in March of 2006, when the U.S. Congress agreed to raise the National Debt Ceiling to just under $9.000 trillion. Viewed alternately as a percentage of the GDP, the national debt rose sharply during World War II, reaching about 122% of GDP in 1946. As soon as the conflict ended, the debt began declining, reaching a postwar low of 32.6% of GDP in 1981. The debt then started rising again and peaked at 67.3% of GDP in 1996. It then dropped to 57.4% of GDP by 2001. The debt of the United States is on par with the debt of other developed countries, such as Germany and France.
Causes Opinions on the causes of the U.S. Federal Budget deficit vary greatly. The three that I have chosen to highlight are a decrease in the private saving rates of Americans, productivity growth and a slump in foreign domestic demand. Proponents of a decline in saving rate are also mainly supporters of the belief in American over-indulgence. Since the mid-1990s, the personal saving rate has declined from roughly 5 percent of disposable income to less than 2 percent, and gross private saving (which includes corporate saving) has edged down from about 16 percent of GDP to less than 15 percent. The decline in saving rates could reflect a structural shift in household saving and spending behavior. Continued financial liberalization and innovation have made it easier for Americans to borrow, particularly against their real estate wealth, and this easing may have led to greater consumption. An impressive achievement of the U.S. economy which has contributed to its skyrocketing budget deficit is the surge in labor productivity growth from about 1-1/2 percent annually in the two decades preceding 1995 to roughly 3 percent in the period since then. This surge is viewed as having several important consequences. First, higher productivity growth boosted perceived rates of return on U.S. investments, thereby generating capital inflows that boosted the dollar. Second, these higher rates of return also led to a rise in domestic investment. Finally, expectations of higher returns boosted equity prices, household wealth, and perceived long-run income, and so consumption rose and saving rates declined. Under this explanation, all of these factors helped to widen the current account deficit. Lastly, domestic demand growth has slumped in many foreign economies because of varying combinations of an increase in saving rates and a decline in investment. This weakening of foreign spending has enhanced the supply of capital available to the United States, put downward pressure on U.S. interest rates, and put upward pressure on the dollar. Some of the largest industrial economies in the world, Japan and Western Europe, have been running current account surpluses while experiencing very subdued growth. In the developing world, the East Asian economies that went through financial crises in the late 1990s have seen a plunge in their investment rates even as their saving rates have remained extremely high; the weakness in domestic demand has likely motivated the authorities in these countries to keep their exchange rates competitive to promote export-led growth, a strategy that has also contributed to the U.S. deficit. In general, since 1999, the developing countries as a whole have been running current account surpluses, with the industrial countries, mainly the United States, necessarily running current account deficits.
The federal budget and the economy are closely interrelated. The strength or weakness of the overall economy affects the levels of outlays and receipts substantially. The budget also has significant effects on the economy, both in terms of how fast the economy grows, and also in terms of the overall allocation of resources. Short-Term Implications
Over fairly short periods of time, say three or four years, fiscal policy can affect the rate of economic growth by adding to, or subtracting from, aggregate demand. Consider, for example, a one-time increase in total federal spending, with no matching rise in tax receipts. Each additional dollar of government spending becomes income for those who satisfy the initial increase in demand for public goods and services. In turn some of that increase in income will be spent, raising the income of those who satisfy a second wave of increased demand for goods and services. Theoretically, this process continues with each successive increment to income getting smaller and smaller as some is saved and some is spent.
Due to the initial increase in spending and the additional spending that is subsequently stimulated, the economy grows somewhat faster than it otherwise would have. For a time, the size of the economy may even increase by more than the initial increase in government spending. Government spending is thus said to have a "multiplier effect."
There can also be a multiplier effect in the case of a spending cut, although the effect is in the opposite direction. If the government reduces spending, that can cut the incomes of those who otherwise would have provided goods and services to the government. If it does, they must either reduce their spending or their saving. To the extent that they cut spending, it adds to the decline in output initiated by the cut in public spending.
The government may also be able to influence the rate of economic growth in the short run via tax cuts or increases. Just as an increase in public sector spending temporarily increases some incomes, so a tax cut increases the amount of income taxpayers have at their disposal. Some of that increase in after tax income is likely to be spent, and so tax cuts may have a multiplier effect just as changes in government spending do. A tax increase reduces disposable income, and so contributes to a slowdown in private sector spending. In the view of most economists, the government cannot permanently increase the size of the economy just by increasing spending, or cutting taxes. As is often the case in economics, other things do not remain equal. An increase in spending, or a tax cut, increases the deficit and so increases the public sector's demand for credit. Increased credit demand tends to raise interest rates. Higher interest rates, in turn, discourage borrowing in the rest of the economy for those activities that depend on credit, especially housing and consumer durable goods.
Higher interest rates also tend to make dollar-denominated financial assets more attractive to overseas investors. In order to buy those assets, however, foreigners must first buy dollars. This increased demand for dollars pushes the foreign exchange value of the dollar above what it otherwise would have been. The "stronger" dollar makes imported goods cheaper, and makes goods and services produced in the United States more expensive abroad. The change in prices tends to increase demand for U.S. imports and reduce demand abroad for U.S. exports, raising the trade, or current budget deficit.
Long-Term Implications A constant deficit or surplus, by itself, is believed to have little if any effect on the short run rate of economic growth. It is changes in the surplus that matter for short run growth. However, whether the budget is in surplus or not does have consequences for the composition of economic output, and that can have an effect on growth in the long run.
In the long run, economic growth is determined primarily by three factors; growth in the labor force, the rate of technological advance, and the amount of capital available to the workforce.
Of the three, the last one may be the most susceptible to the influence of policymakers. The larger the capital stock, the more productive the labor force tends to be.
While it may be possible for fiscal policy to have an effect on the rate of technological progress in the way public money is spent, it probably has a much larger effect on growth through its influence on the size of the domestic stock of capital and the amount of capital available to each worker in the labor force. The total value of national output can be measured in two ways. Either the total value of the goods and services produced can be added up, or the total value of the incomes resulting from that production can be counted.
The measure of total output based on the value of production is typically subdivided into several categories of demand. Specifically, it is calculated as the sum of consumption spending (C), investment (I), government spending (G) and the difference between exports (X) and imports (M):
GDP = C + I + G + (X - M) The alternative measure of total output is the sum of the various uses to
which income is allocated. On this side of the economic accounting ledger the value of national output is expressed as the sum of consumption (C), private sector saving (S), and tax payments (T):
GDP = C + S + T
Combining the two equations, and simplifying gives:
I = S + (T - G) + (M - X)
Total investment spending is equal to the sum of private saving (S), the government budget surplus (T - G, which, if it is negative, is a deficit), and the difference between imports and exports of goods and services (M - X). Therefore investment is by definition equal to the sum of private saving, the budget surplus, and net capital inflows from abroad. Other things being equal, a reduction in public sector saving means less investment and slower growth in the capital stock.
Reducing the Federal Debt
Perhaps the most obvious effect of the federal government budget surpluses of the 1990s was a decline in the amount of federal debt. From an economic perspective, however, the measure of debt that matters more is not the absolute level in dollar terms, but rather the debt relative to total output, or GDP. From this perspective, the debt began to fall in 1993.
Many economists believe that a steadily growing federal debt is not by itself a cause for concern. As long as the federal debt grows faster than GDP, however, interest payments on that debt will constitute an ever-increasing share of total federal spending and of GDP. If investors should come to expect that the debt would grow faster then GDP indefinitely, and that the debt-to-GDP ratio would continue to rise, they might eventually become unwilling to buy new issues of federal debt.
In the long run, the relationship between the growth rate of the federal debt and the overall rate of economic growth is critical to financial stability. Perpetual growth in the debt in excess of the rate of economic growth is an inherently unstable situation. It is likely that investors would become unwilling to buy federal debt issues long before all of GDP was accounted for by the interest payment on the federal debt, because of growing doubts about the government's ability to raise sufficient revenue to pay the interest on that debt.
Thus even with a budget deficit, the ratio of debt to national income can fall.
For the United States, the recent peak level of the federal debt relative to GDP was reached in 1993 at 49.4%, when the budget deficit was $255 billion. In 1994, even though the deficit was still over $200 billion, the debt fell relative to GDP. By 2001, federal debt had fallen to a low of 33.0% of GDP. In 2002, the ratio of debt to GDP began to rise for the first time in eight years, and in 2004 stood at 37.2%.
http://www.publicdebt.treas.gov/opd/opdfaq.htm#opdfaq12 http://www.publicdebt.treas.gov/opd/opdhisto4.htm