1 Chapter 17 Federal Deficits and the National Debt Key Concepts Key Concepts Summary ©2000 South-Western College Publishing

2 What is the purpose of this chapter? To take a closer look at the actual budgetary process that creates and finances our national debt

3 What are the four stages of the budget process? Formation of the budget Presidential budget submission Budget resolution Budget passed

4 Formation of Budget February – December (previous year) Presidential Budget Submission January Budget Resolution May Budget Passed September

5 What is the federal fiscal year? October 1 through September 30

6 What is the federal deficit? How much money the government borrows in any given fiscal year

7 What is the national debt? The total amount owed by the federal government to owners of government securities

8 How does the U.S. treasury borrow money? By selling Treasury bills, notes, and bonds, promising to make specified interest payments and to repay the loaned funds on a given date

9 60 $200 Billions of dollars $400 $1,600 $600 $800 $1,000 $1,200 $1, Expenditures Revenues 00 Year $1,800 Federal Expenditures and Tax Revenues

10 17 Percentage of GDP Federal Expenditures, Revenues, and Deficits as a Percentage of GDP Federal Deficit Year

11 65 $ $-200 $ Deficit 95 Federal Budget Surpluses and Deficits Billions of dollars 60 Surplus $

12 What is a debt ceiling? The legislated legal limit on the national debt

13 What usually happens when the debt pushes against the ceiling? Congress raises the ceiling to accommodate the budget deficit

Year $1 $2 $3 $4 $5 $6 National debt The National Debt 00 Trillions of dollars

Year National debt/GDP Percentage of GDP World War II The National Debt as a Percentage of GDP 00

16 What is the internal national debt? The portion of the national debt owed to a nation’s own citizens

17 What is the external national debt? The portion of the national debt owed to foreign citizens

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% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 4.0% Federal Net Interest as a Percentage of GDP Year Percentage of GDP

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21 What is the crowding-out effect? When federal government borrowing increases interest rates, the result is lower consumption and investments

22 Can the government go bankrupt? Yes, it’s possible No, the debt need never be paid off

23 Are we passing the debt burden to our children? Yes, especially if it continues to increase No, not as long as the debt is internally owned

24 Does government borrowing crowd out private-sector spending? Yes, the more the government borrows the less loanable funds for everyone else No, especially if it occurs during economic downturns

AD 1 AS AD` AD 2 E2E2 E1E1 E` 2 Full Employment Complete (AD 1 ), Partial (AD` 2 ), and Zero (AD 2 ) Crowding Out

26 Government spends & borrows Government competes with private borrowers Interest rates rise Consumer & business spending decrease AD and real GDP increase dampened

27 Key Concepts

28 Key Concepts What is the Federal Deficit? What is the National Debt? How does the U.S. Treasury borrow money?How does the U.S. Treasury borrow money? What has been done to curb the National Debt?What has been done to curb the National Debt? What is a Debt Ceiling?

29 Key Concepts cont. What is the Internal National Debt? What is the External National Debt? What is the Crowding-out Effect? Can the Government go Bankrupt? Are we passing the Debt Burden to our Children?Are we passing the Debt Burden to our Children? Does Government Borrowing Crowd Out Private-sector Spending?Does Government Borrowing Crowd Out Private-sector Spending?

30 Summary

31 The national debt is the dollar amount that the federal government owes holders of government securities. It is the cumulative sum of past deficits. The U.S. Treasury issues government securities to finance the deficits. The debt has more than tripled since The debt ceiling is a method to restrict the national debt.

Year $1 $2 $3 $4 $5 $6 National debt The National Debt 00 Trillions of dollars

33 Internal national debt is the percentage of the national debt a nation owes to its own citizens. In 1998, abut 83% of the national debt was internally held by individuals, banks, corporations, insurance companies, and government entities. The “we owe it to ourselves” argument over the debt is the U.S. citizens own the bulk of the national debt.

34 External debt is a burden because it is the portion of the national debt a nation owes to foreigners. The interest paid on external debt transfers purchasing power to other nations. In 1998, approximately 17% of the national debt was external.

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36 The crowding-out effect is a burden of the national debt that occurs when the government borrows to finance its deficit, causing the interest rate to rise. As the interest rate rises, consumption and business investment fall. The burden of debt debate involves controversial questions:

37 Can Uncle Sam GO Bankrupt? The national debt is a lower percentage of GDP today than at the end of World War II. The U.S. government will not go bankrupt because it never has to pay off its debt. When government securities mature, the U.S. Treasury can refinance or roll over the debt by issuing new securities.

38 Are We Passing the Debt Burden to Our Children? NO One side of this argument is that the debt is mostly internal, so financing a deficit only involves exchanging old bonds for new bonds among U.S. citizens. The burden of the debt falls only on the current generation when the trade-off between public-sector goods and private sector goods along the production possibilities curve occurs.

39 Are We Passing the Debt Burden to Our Children? YES The sizeable external debt transfers purchasing power to foreigners.

40 Does Government Borrowing Crowd Out Private Sector Spending? Keynesian theory assumes zero crowding out when the federal government increases spending in order to shift the aggregate demand curve rightward. If crowding out occurs, reduced private spending offsets the multiplier effect of increased government spending. As a result, the expected magnitude of the rightward shift in the aggregate demand curve is partially or completely offset.

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