Part 2

Deficit and Debt

Chapter 15-2

Chapter GoalsChapter Goals Define the terms deficit, surplus, and debt and

distinguish between a cyclical deficit and a structural deficit

Differentiate between real and nominal deficits and surpluses

Explain why the debt needs to be judged relative to assets

Describe the historical record for the U.S. deficit and debt

Defining Deficits and SurplusesA deficit is a shortfall of revenues under payments

A surplus is an excess of revenues over payments

In the short run, if the economy is below potential, deficits are good because deficits increase expenditures moving output closer to potential

Long-run surpluses are good because they provide saving for investment

Financing the DeficitThe government finances its deficits by selling

bonds to private individuals and to the central bank

Bonds are promises to pay back the money in the future

The central bank can print an unlimited amount of money to buy bonds, but printing too much money can cause serious inflation

Short Run vs. Long Run

Arbitrariness in Defining Surpluses and Deficits

Whether a nation has a deficit or surplus depends on what is included as

revenuesrevenues and expendituresexpenditures

There are many ways to measure expenditures and receipts, so there are many ways to measure deficits

and surpluses

Deficit and surplus figures are summary measures of the

financial health of the economy

To understand the summary, you must understand the

methods that were used to calculate it

Many government revenues and expenditures depend on the level of income in the economy

Expenditures are not straight forward!

What? .

Structural and Cyclical Deficits and Surpluses

Structural deficit is the part of the budget deficit that would exist even if the economy were at its potential level of output

Cyclical deficit is the part of the deficit that exists because the economy is operating below its potential level of output

The Federal Budget Deficit & The Business CycleThe budget deficit as a percentage of GDP tends to rise during recessions (indicated by shaded areas) and fall during expansions.

These Deficits help end the

recessions

ACTUAL DEFICIT = STRUCTURAL DEFICIT + CYCLICAL DEFICIT

Actual deficit = structural deficit + cyclical deficit

CYCLICAL DEFICIT = TAX RATE X (POTENTIAL – ACTUAL OUTPUT)

Cyclical deficit = tax rate x (potential – actual output)

STRUCTURAL DEFICIT = ACTUAL DEFICIT – CYCLICAL DEFICIT

Structural deficit = actual deficit – cyclical deficit

Structural and Cyclical Deficits and Surpluses

There is disagreement about what percentage of a deficit is structural and what percentage is cyclical

According to your textbook

• Much of the current deficit is structural and will have to continue to keep the economy where it is today; however, it cannot continue indefinitely

Cyclical Deficits

• During Recession the During Recession the number of unemployednumber of unemployed

. . Tax Revenue

• # of Unemployed Government . # of Unemployed Government . …. …. Spending on Spending on . . Transfer Transfer payment payment

A Depressing Idea

• Structural Stagnation Theory Structural Stagnation Theory seesMuch of the unemployment as

StructuralStructuralNOT CyclicalCyclical

Projections for the Budget Deficit

Percent of GDP

1990 1994 1998 2002 2006 2010 2014 2018

4

2

0

-2

-4

-6

-8

-10

-12

-14

History Forecast2009 Projection

2012 CBO Projection

Actual

Nominal and Real Deficits and Surpluses

A nominal deficit is the difference between expenditures and receipts

A real deficit is the nominal deficit adjusted for inflation

Inflation reduces the value of the debtdebt

Real deficit = Nominal deficit – (Inflation x

Real deficit = Nominal deficit – (Inflation x Total debt

Total debt))

Side Effects Include

• Lowering the real deficit real deficit by inflation is not costless to the government • Persistent inflation becomes built into

expectations and causes higher interest rates

?But wait… There’s More!

Next Slide Covers Debt! The Debt is different from the Deficit…..