Macroeconomics
Unit 12
Deficits, Surpluses, Debt
Top Five Concepts
Introduction
In this unit we discuss the federal budget process and common
budgetary problems.
Does the amount of the federal deficit cause a problem with
other sectors of our economy?
Should we have a balanced federal budget? All the time or just
when our economy is at full employment?
Concept 1: Budget Surpluses and Deficits
A budget deficit is the amount by which government spending
exceeds government revenue in a given time period.
Deficit spending is the use of borrowed funds to finance
federal government expenditures that exceed tax revenues.
A budget surplus is an excess of government revenues over
government expenditures in a given time period.
Are Budget Deficits Bad?
According to Keynes, the goal of macro policy is to balance the
economy at full employment.
A budget deficit that is used to shift aggregate demand towards
full employment is acceptable according to Keynes.
Keynes believed that a balanced budget is appropriate only if
leakages and injections are in balance and the economy is at
full employment equilibrium.
Concept 2: Discretionary & Automatic Spending
The size and scope of the federal budget makes it difficult to
control. Because of prior spending commitments, it is difficult
to reduce spending in any given year.
The expenditures in the current budget are 80%
uncontrollable; they are based upon prior years decisions.
The remaining 20% of the budget is for discretionary fiscal
spending. Simply put, only 20% of the budget is “up for grabs”
in any given year.
Concept 2: Discretionary & Automatic Spending
Discretionary fiscal spending consists of those elements of
the federal budget not determined by past legislative or
executive commitments.
Because discretionary spending is only 20% of the budget,
changes in spending policy are smaller than possibly desired
because of prior commitments.
Many of the uncontrollable expenditures in the federal budget
increase or decrease based upon economic conditions.
Concept 2: Discretionary & Automatic Spending
Automatic stabilizers are federal expenditure or revenue
items that automatically respond counter cyclically to changes
in national income.
Unemployment benefits and income taxes are examples of
automatic stabilizers.
Unemployment benefits paid increase as the economy heads
into a recession or economic slowdown. They act as an
injection. Income tax collections decline in economic
slowdowns and increase during growth.
Concept 3: Deficit Types
It should be obvious that the size of the federal deficit is
affected by economic expansion or contraction, as well as
politics.
Cyclical deficits are that portion of the budget balance
attributable to short-run changes in economic conditions.
For example, as unemployment increases, the dollar amount of
unemployment benefits paid increases, causing a cyclical
deficit.
Concept 3: Deficit Types
Deficits can also occur as a result of policy decisions.
If the economy is at full employment and deficits continue to
exist, they exist as a result of discretionary fiscal policy
decisions. Excessive spending may be due to war or other
external factors, or the inability of elected officials to reduce
spending.
Structural deficits occur when federal revenues at full
employment are less than federal expenditures at full
employment. The federal government is spending more than it
is receiving in tax revenue.
Concept 3: Deficit Types
If a structural deficit exists when the economy is at full
employment, the likely causes include:
• Excessive federal spending.
• Lower tax rates.
Discretionary fiscal restraint or increased taxes can eliminate
structural deficits. The federal government needs to spend less
money or raise taxes to cover the current level of spending if a
balanced budget is desired.
Concept 3: Deficit Types
Fiscal stimulus (the increase in budget expenditures or
decrease in tax revenues) is measured by the increase in the
structural deficit (or shrinkage in the structural surplus). In
recessionary periods, the structural deficit should be increasing.
Fiscal restraint is measured by the decrease in the structural
deficit (or increase in the structural surplus). During times of
full employment, the structural surplus should be increasing
and/or no structural deficit should exist.
Economic Effects of Deficits
To finance deficits, the government needs to borrow more
money from the private sector.
The federal government sells government securities like
treasury bills to finance spending.
Because federal government securities are an attractive
investment and very secure, the government securities can
“crowd out” some of the private securities being sold (bonds
from GE, etc.).
Economic Effects of Deficits
Crowding Out is the reduction in private-sector borrowing (and
spending) caused by increased government borrowing.
If the government increases its borrowing, private companies
may not be able to offer securities for sale. The interest rates
necessary to make private investment attractive may be too
costly for business. Private investment is then reduced.
Therefore the increase in government spending financed by
securities has a lesser effect on economic expansion since
private investment and consumption may be reduced.
Economic Effects of Surpluses
Budget surpluses, although rare in recent years, are a unique
situation.
The surplus can be:
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Spent by the government on goods and services.
Given back to the public as a tax cut.
Used to increase income transfers.
Used to pay off old debt (the national debt).
If the last option is chosen, crowding in occurs.
Economic Effects of Surpluses
Crowding In is an increase in private-sector borrowing (and
spending) caused by decreased government borrowing.
The economic effects of crowding in cause increased borrowing
by business to expand investment and increased output.
Less government borrowing also reduces interest rates.
Federal Government Debt
For each year that deficit spending occurs, the annual amount
of the deficit is added to the federal government’s total debt.
National debt refers to the total accumulated debt of the
federal government from deficit spending.
Most of the federal government debt is in the form of Treasury
bonds, bills and Savings bonds.
The level of debt has varied historically.
Concept 4: Issues with the National Debt
Approximately 50% of the debt is held by federal
agencies like the Federal Reserve and state and local
governments.
About 80% of the national debt is internal debt. Internal
debt is U.S. government debt that is held by U.S.
households and institutions. The remaining 20% is held
by foreign governments, institutions, and households.
This is external debt.
More information on the national debt can be found at
http://www.treasurydirect.gov/govt/govt.htm
National Debt Costs
Interest payments made on the debt use funds that could be
used by other programs.
There are opportunity costs associated with the debt. Did
deficit spending produce more desired results than having a
reduced amount of national debt? The opportunity costs
associated with deficit spending tend to be limited to the year in
which they occurred.
External debt does not crowd out private-sector borrowing (to
some extent), and investment.
Concept 5: Limits on the Debt
Limitations are placed on annual deficits
and the national debt.
A deficit ceiling is an explicit, legislated
limitation on the size of the budget deficit.
A debt ceiling is an explicit, legislated limit
on the amount of outstanding national debt.
If you want to reduce the national debt you
must first eliminate deficits.
Future Problems – Federal Budget
Will Congress and the President be able to exercise fiscal
restraint in the future?
Will deficits be only permitted in times of recession or war?
Should taxes be increased or decreased?
Should the federal government stop spending the Social
Security surplus on other programs?
Is government supposed to help companies and individuals
during times of economic stress or loss? If so, for how long?
Summary
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Deficit spending.
Budget surplus and deficit.
Discretionary spending.
Fiscal restraint and stimulus.
Automatic stabilizers.
Cyclical and structural deficits.
Crowding In and Crowding Out.
National debt; internal and external debt.
Opportunity cost of debt.
Debt and deficit ceilings