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1 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Deficits And Debt Chapter 19

2 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Laugher Curve How many neoclassical economists does it take to change a lightbulb?

3 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Laugher Curve How many neoclassical economists does it take to change a lightbulb? It depends on the wage rate.

4 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Chapter Objectives u Define the terms deficit and debt.

5 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Chapter Objectives u Define the terms deficit and debt. u State why economists focus on financial health rather than on deficits.

6 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Chapter Objectives u Explain why, in an expanding economy, a government can run a limited, but continual, deficit without serious concern about the consequences.

7 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Chapter Objectives u Differentiate between a real deficit and a nominal deficit.

8 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Chapter Objectives u Explain why, even though the real budget deficit of the United States is much lower than the nominal deficit, there is still reason for concern about the deficit.

9 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Chapter Objectives u Explain why there are alternative reasonable views about the deficit.

10 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill U.S. Government Deficits and Debt u Introductory Definitions

11 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill U.S. Government Deficits and Debt u Introductory Definitions l A deficit is a shortfall of incoming revenues under outgoing payments—it is a flow concept.

12 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill U.S. Government Deficits and Debt u Introductory Definitions l If revenues exceed payment, you are running a surplus.

13 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill U.S. Government Deficits and Debt u Introductory Definitions l If revenues exceed payment, you are running a surplus. l If the opposite happens, you are running a deficit.

14 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill U.S. Government Deficits and Debt u Introductory Definitions l Debt is accumulated deficits minus accumulated surpluses—it is a stock concept.

15 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill U.S. Government Deficits and Debt u Introductory Definitions l As debt accumulates, governments must borrow to pay the interest.

16 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill U.S. Government Deficits and Debt u Why has the U.S. consistently run deficits since World War II?

17 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill U.S. Government Deficits and Debt u Why has the U.S. consistently run deficits since World War II? l The reason is a change in macroeconomic policy regimes—the general set of rules that governs the monetary and fiscal policies that a nation follows.

18 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill U.S. Government Deficits and Debt u Why has the U.S. consistently run deficits since World War II? l Keynesians, in arguing in favor of deficit spending, removed its stigma.

19 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill U.S. Government Deficits and Debt u Why has the U.S. consistently run deficits since World War II? l As deficits grew, they were blamed for its growth.

20 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill U.S. Government Deficits and Debt u Why has the U.S. consistently run deficits since World War II? l The modern Classical supply-side regime of the 1980s, resulted in even greater deficits than those run up by the Keynesians.

21 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill U.S. Government Deficits and Debt u The public dislikes both deficits and debt.

22 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill U.S. Government Deficits and Debt u The public dislikes both deficits and debt. l The Gramm-Rudman-Hollings Act of 1985 established mandatory deficit targets for the U.S. in an effort to meet public demands for their elimination.

23 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill U.S. Government Deficits and Debt u The public dislikes both deficits and debt. l Since the law proved ineffective, the Budget Enforcement Act of 1990 was enacted.

24 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill U.S. Government Deficits and Debt u The public dislikes both deficits and debt. l The Budget Enforcement Act of 1990 put caps on certain aspects of federal spending, and established a pay-as-you-go test for new spending or tax cuts.

25 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill U.S. Government Deficits and Debt u The public dislikes both deficits and debt. l Up until 1996, any new legislation, except for emergencies, must be accompanied by offsetting tax increases or spending cuts.

26 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill U.S. Government Deficits and Debt u The public dislikes both deficits and debt. l As these laws, and others proved weak, some politicians demanded a balanced budget amendment to the Constitution.

27 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill U.S. Government Deficits and Debt u The public dislikes both deficits and debt. l It was felt that without the amendment, American politics lacks the political will to prevent deficit spending.

28 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill U. S. Budget Deficits

29 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill U. S. Government Debt 5,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0 Years 19501960197019801990 2000 2010 $5,500

30 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Economists’ Way of Looking at Deficits and Debt u Arbitrariness in Defining Deficits

31 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Economists’ Way of Looking at Deficits and Debt u Arbitrariness in Defining Deficits l How one defines a revenue and an expenditure is crucial.

32 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Economists’ Way of Looking at Deficits and Debt u Arbitrariness in Defining Deficits l Should capital equipment be charged off completely the year it was bought or be depreciated over its useful life?

33 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Economists’ Way of Looking at Deficits and Debt u Arbitrariness in Defining Deficits l Should the gain in the market value of an issued U.S. government obligation be counted as additional revenue or ignored?

34 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Economists’ Way of Looking at Deficits and Debt u Arbitrariness in Defining Deficits l Putting aside the issue of “cooking the books,” reasonable people can disagree on how to handle government revenue and expenditures.

35 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Economists’ Way of Looking at Deficits and Debt u Deficits As a Summary Measure

36 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Economists’ Way of Looking at Deficits and Debt u Deficits As a Summary Measure l The deficit is a summary measure of the financial health of the economy—a single figure.

37 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Economists’ Way of Looking at Deficits and Debt u Deficits As a Summary Measure l Therefore, to understand the summary, you must understand the logic used to calculate it.

38 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Economists’ Way of Looking at Deficits and Debt u The Need to Judge Deficits Relative to Assets

39 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Economists’ Way of Looking at Deficits and Debt u The Need to Judge Deficits Relative to Assets l Debt, being a summary measure of a nation’s accumulated deficits, has even more problems than deficits.

40 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Economists’ Way of Looking at Deficits and Debt u The Need to Judge Deficits Relative to Assets l Debt is only half the picture—the other half being assets.

41 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Economists’ Way of Looking at Deficits and Debt u The Need to Judge Deficits Relative to Assets l Debt must be judged in its relation to assets.

42 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Economists’ Way of Looking at Deficits and Debt u Arbitrariness in Defining Debt

43 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Economists’ Way of Looking at Deficits and Debt u Arbitrariness in Defining Debt l Assets and debt are subject to varying definitions.

44 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Economists’ Way of Looking at Deficits and Debt u Arbitrariness in Defining Debt l There is no perfectly objective and universal way of defining how debt and assets should be valued.

45 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Economists’ Way of Looking at Deficits and Debt u Difference Between Individual and Government Debt

46 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Economists’ Way of Looking at Deficits and Debt u Difference Between Individual and Government Debt l Government debt is different than an individual’s debt.

47 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Economists’ Way of Looking at Deficits and Debt u Difference Between Individual and Government Debt l Since government is ongoing, it never has to settle its accounts as when an individual dies.

48 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Economists’ Way of Looking at Deficits and Debt u Difference Between Individual and Government Debt l Governments can pay off debt by creating money.

49 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Economists’ Way of Looking at Deficits and Debt u Difference Between Individual and Government Debt l Much of government debt is internal government debt, debt owed to its own citizens.

50 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Economists’ Way of Looking at Deficits and Debt u Difference Between Individual and Government Debt l This means that the government must collect taxes to pay the debt which is giving to the debt holders as income.

51 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Economists’ Way of Looking at Deficits and Debt u Difference Between Individual and Government Debt l Not counting the distribution effects (the same people may not be involved) the nation is neither richer nor poorer.

52 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Economists’ Way of Looking at Deficits and Debt u Difference Between Individual and Government Debt l External government debt on the other hand is debt owed individuals in foreign nations.

53 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Economists’ Way of Looking at Deficits and Debt u Difference Between Individual and Government Debt l Paying interest on it means a net reduction in domestic income.

54 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Economists’ Way of Looking at Deficits and Debt u Deficits, Debt, and Debt Service Relative to GDP

55 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Economists’ Way of Looking at Deficits and Debt u Deficits, Debt, and Debt Service Relative to GDP l Government deficits and debt relative to GDP is less alarming compared to government deficits and debt in absolute terms.

56 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Economists’ Way of Looking at Deficits and Debt u Deficits, Debt, and Debt Service Relative to GDP l Measuring deficits and debt relative to GDP highlights a nation’s productive capacity relative to debt management.

57 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Economists’ Way of Looking at Deficits and Debt u Deficits, Debt, and Debt Service Relative to GDP l Although the absolute size of the deficits and debt have grown since World War II, their importance relative to GDP have not.

58 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Budget Deficits as a Percentage of GDP Years Deficits as percentage of GDP 10 0 –10 –20 –30 1900191019201930194019501960197019801990

59 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Debt as a Percentage of GDP Debt as percentage of GDP 1980 100 75 50 25 0 Years 1800182018401860188019001920194019602000

60 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Economists’ Way of Looking at Deficits and Debt

61 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Economists’ Way of Looking at Deficits and Debt u Economists are also concerned about the interest rate paid on debt.

62 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Economists’ Way of Looking at Deficits and Debt u Economists are also concerned about the interest rate paid on debt. l Debt service is the interest rate on debt times the total debt.

63 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Economists’ Way of Looking at Deficits and Debt u Economists are also concerned about the interest rate paid on debt. l Debt service as payment for past expenditures puts a burden on future generations.

64 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Economists’ Way of Looking at Deficits and Debt u Economists are also concerned about the interest rate paid on debt. l Debt service payments relative to GDP suggests that it is a greater problem than the debt/GDP measure, but less of a problem than absolute debt.

65 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Economists’ Way of Looking at Deficits and Debt u Economists are also concerned about the interest rate paid on debt. l The U.S. can actually afford more debt since U.S. government securities are considered the safest in the world.

66 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Federal Interest Payments Relative to GDP

67 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill GDP Growth Reduces Problems Posed by Deficits

68 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill GDP Growth Reduces Problems Posed by Deficits u Structural Deficits, Cycles and Growth

69 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill GDP Growth Reduces Problems Posed by Deficits u Structural Deficits, Cycles and Growth l As aggregate income increases, tax revenues increase and the deficit declines.

70 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill GDP Growth Reduces Problems Posed by Deficits u Structural Deficits, Cycles and Growth l As aggregate income increases, tax revenues increase and the deficit declines. l The opposite occurs as aggregate income falls.

71 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill GDP Growth Reduces Problems Posed by Deficits u Structural Deficits, Cycles and Growth l The structural deficit is the deficit that would remain when these cyclical elements have been netted out.

72 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill GDP Growth Reduces Problems Posed by Deficits u Structural Deficits, Cycles and Growth l The structural deficit is the deficit that would remain when these cyclical elements have been netted out. l This would result in an economy at its potential income.

73 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill GDP Growth Reduces Problems Posed by Deficits u Real Growth and the Deficit

74 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill GDP Growth Reduces Problems Posed by Deficits u Real Growth and the Deficit

75 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill GDP Growth Reduces Problems Posed by Deficits u Real Growth and the Deficit l Some argue that as long as the economy is growing in real terms, and the debt/GDP ratio is maintained, the debt can grow without deleterious effects.

76 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill GDP Growth Reduces Problems Posed by Deficits u Real Growth and the Deficit l Others argue that the debt-GDP ratio is already too high and should be brought down.

77 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill GDP Growth Reduces Problems Posed by Deficits u Inflation, Debt, and the Real Deficit

78 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill GDP Growth Reduces Problems Posed by Deficits u Inflation, Debt, and the Real Deficit l Inflation wipes out debt.

79 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill GDP Growth Reduces Problems Posed by Deficits u Inflation, Debt, and the Real Deficit l The larger the debt and the larger the inflation, the more debt will be eliminated with inflation.

80 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill GDP Growth Reduces Problems Posed by Deficits u Inflation, Debt, and the Real Deficit l If inflation is wiping out debt, and the deficit is equal to the increases in debt from one year to the next, inflation also affects the deficit.

81 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill GDP Growth Reduces Problems Posed by Deficits u Inflation, Debt, and the Real Deficit l A nominal deficit is the deficit determined by looking at the difference between expenditures and receipts.

82 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill GDP Growth Reduces Problems Posed by Deficits u Inflation, Debt, and the Real Deficit l A real deficit is the nominal deficit adjusted for inflation’s effect on the debt.

83 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill GDP Growth Reduces Problems Posed by Deficits u Inflation, Debt, and the Real Deficit l A real deficit is the nominal deficit adjusted for inflation’s effect on the debt. real deficit = nominal deficit - (inflation x total debt)

84 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill GDP Growth Reduces Problems Posed by Deficits u Inflation, Debt, and Nominal Deficits

85 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill GDP Growth Reduces Problems Posed by Deficits u Inflation, Debt, and Nominal Deficits l Inflation wipes out debt, and that fact must be considered when evaluating the effect of a deficit.

86 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill GDP Growth Reduces Problems Posed by Deficits u Inflation, Debt, and Nominal Deficits l Inflation is not a costless answer to eliminating debt.

87 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill GDP Growth Reduces Problems Posed by Deficits u Inflation, Debt, and Nominal Deficits l The government’s gain from an inflation is the private bond holder’s loss from inflation.

88 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill GDP Growth Reduces Problems Posed by Deficits u Nominal and Real Interest Rates and Deficits

89 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill GDP Growth Reduces Problems Posed by Deficits u Nominal and Real Interest Rates and Deficits l Expectations of inflation push up the nominal interest rate and cause bond holders to demand an inflation premium on their bonds.

90 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill GDP Growth Reduces Problems Posed by Deficits u Nominal and Real Interest Rates and Deficits l Future expectations of inflation causes the real interest rate to be different form the nominal interest rate.

91 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill GDP Growth Reduces Problems Posed by Deficits u Nominal and Real Interest Rates and Deficits l If bond holders don’t lose when they make a full adjustment for expected inflation, government cannot win.

92 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill GDP Growth Reduces Problems Posed by Deficits u Nominal and Real Interest Rates and Deficits l With full adjustments in expectations, creditors don’t lose. See numerical example on page 473 of the textbook.

93 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Summary to This Point u Deficits are summary measures of the state of the economy.

94 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Summary to This Point u Deficits are summary measures of the state of the economy. u They are dependent on the accounting procedures used.

95 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Summary to This Point u It is the financial health of the economy, not the deficit, with which we should be concerned.

96 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Summary to This Point u Deficits and debt should be viewed relative to GDP to determine their importance.

97 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Summary to This Point u The real deficit is the nominal deficit adjusted for the inflation reduction in the real debt.

98 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Reasons for Concern About Budget Deficits u The U.S. does not include many government obligations.

99 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Reasons for Concern About Budget Deficits u The U.S. does not include many government obligations. l The U.S. uses a cash flow accounting system—an accounting system entering expenses and revenues only when cash is received or paid out.

100 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Reasons for Concern About Budget Deficits u The U.S. does not include many government obligations. l The cash flow accounting system leads to a number of distortions in the budget and deficit.

101 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Reasons for Concern About Budget Deficits u The U.S. does not include many government obligations. l A number of government obligations do not show up as part of the deficit.

102 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Reasons for Concern About Budget Deficits u The government uses accounting tricks to make the deficit look smaller.

103 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Reasons for Concern About Budget Deficits u The government uses accounting tricks to make the deficit look smaller. l In the S&L bailout, the government increased insurance fees on member institutions and counted them as revenue.

104 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Reasons for Concern About Budget Deficits u The government uses accounting tricks to make the deficit look smaller. l Since they were not nearly enough to cover the costs, the government sold special bonds which were not counted as expenditures.

105 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Reasons for Concern About Budget Deficits u The government uses accounting tricks to make the deficit look smaller. l These are called off-budget expenditures, expenditures of money that are not counted as expenditures in the budget.

106 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill The Social Security Retirement System u Funded and Unfunded Retirement Systems

107 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill The Social Security Retirement System u Funded and Unfunded Retirement Systems l A funded pension system is one in which money is collected and invested in a special fund from which pension payments are made.

108 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill The Social Security Retirement System u Funded and Unfunded Retirement Systems l An unfunded pension system is one in which pensions are paid from current revenues.

109 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill The Social Security Retirement System u Funded and Unfunded Retirement Systems l The social security system is largely an unfunded pension system.

110 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill The Social Security Retirement System u Funded and Unfunded Retirement Systems l The problem with this is that there is no trust fund of assets earning interest to cover future payments.

111 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill The Social Security Retirement System u A Potential Problem With Unfunded Systems

112 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill The Social Security Retirement System u A Potential Problem With Unfunded Systems l The potential problem is that the amount paid out exceeds the amount paid in.

113 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill The Social Security Retirement System u A Potential Problem With Unfunded Systems l As long as each succeeding generation remains about the same size, the process works.

114 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill The Social Security Retirement System u A Potential Problem With Unfunded Systems l If there is a baby boom generation, followed by normal-sized generations, when the baby boomers begin to retire, there is not enough money being paid into the system to sustain them. l There are a number of ways to deal with this. u Partially fund the system. u Raise the retirement age.

115 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill The Social Security Retirement System u Social Security and the Budget Deficit l The government responded to the unfunded social security system by raising the retirement age slightly and legislating a large increase in the rate of social security contributions.

116 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill The Social Security Retirement System u A Potential Problem With Unfunded Systems l The tax increase was to fund a large trust fund.

117 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill The Social Security Retirement System u A Potential Problem With Unfunded Systems l Unfortunately, deficit spending grew apace so the government was forced to finance the trust fund by issuing bonds as a promise to pay for funding the trust fund.

118 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill The Social Security Retirement System u An Alternative

119 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill The Social Security Retirement System u An Alternative l Raise the eligibility age so that by 2010, it will stand at 70 years.

120 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill The Social Security Retirement System u An Alternative l Lower the current social security tax rates by 10 percent.

121 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill The Social Security Retirement System u An Alternative l The effect would be an increase in the current budget deficit accompanied by an increase in U.S. financial strength.

122 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill The Deficit Debate: Wolves, Pussycats, or Termites u Three Alternative Views of the Deficit

123 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill The Deficit Debate: Wolves, Pussycats, or Termites u Three Alternative Views of the Deficit l The wolf-at-the-door group believes that the deficit will bring about imminent doom.

124 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill The Deficit Debate: Wolves, Pussycats, or Termites u Three Alternative Views of the Deficit l The wolf-at-the-door group believes that the deficit will bring about imminent doom. l Few economists belong to this group.

125 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill The Deficit Debate: Wolves, Pussycats, or Termites u Three Alternative Views of the Deficit l The domesticated-pussycat group believes that the deficit does not matter.

126 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill The Deficit Debate: Wolves, Pussycats, or Termites u Three Alternative Views of the Deficit l The domesticated-pussycat group believes that the deficit does not matter. l A small but vocal group belong to this group.

127 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill The Deficit Debate: Wolves, Pussycats, or Termites u Three Alternative Views of the Deficit l The termites-in-the-basement group believes that continuing deficits will cause serious problems in the long run.

128 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill The Deficit Debate: Wolves, Pussycats, or Termites u Three Alternative Views of the Deficit l The termites-in-the-basement group believes that continuing deficits will cause serious problems in the long run. l The largest number of economists belong to this group.

129 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill The Deficit Debate: Wolves, Pussycats, or Termites u Who’s Right?

130 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill The Deficit Debate: Wolves, Pussycats, or Termites u Who’s Right?

131 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill The Deficit Debate: Wolves, Pussycats, or Termites u Who’s Right? l The Proxmire letter mirrors the views of most lay people’s views of the deficit.

132 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill The Deficit Debate: Wolves, Pussycats, or Termites u Who’s Right? l Eisner’s response represents the views of liberal Keynesian economists, of which he is one.

133 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill The Deficit Debate: Wolves, Pussycats, or Termites u Who’s Right? l Some Classical economists believe deficits don’t matter because people are rational and fully discount future tax payments deficits would entail.

134 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill The Deficit Debate: Wolves, Pussycats, or Termites u Who’s Right? l The Modigliani/Solow response to Eisner argues that the deficits are gnawing away at the structure of the economy.

135 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill The Deficit Debate: Wolves, Pussycats, or Termites u Who’s Right? l The economy is fundamentally sick and using slick accounting Band-Aids will not cure the illness.

136 © The McGraw-Hill Companies, Inc., 1998 Irwin/McGraw-Hill Comparisons of Government Debt to GDP


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