The Federal Budget and the National Debt

Outline:

•The federal deficit (surplus) defined—again

•The record of of the federal budget

•The automatic stabilizers.

•Why a federal deficit has an expansionary effect on real GDP and employment.

•The national debt defined

•The record of the national debt

•Should we be concerned about a large national debt?

Let:

•G denote federal spending for goods and services in a fiscal year (Oct. 1 thru Sept. 30).

•TX is federal tax receipts.

•TR is federal transfer payments.

•T is federal net taxes (TX - TR)

If G exceeds T in a fiscal year, then we have a federal deficit.

If, however, T exceeds G, then we have

a federal surplus.

Federal Outlays and Receipts, 1993-99

1000

1100

1200

1300

1400

1500

1600

1700

1800

93 94 95 96 97 98 99

billions

ReceiptsOutlays

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Taxes (TX) and Transfer Payments (TR) are called “automatic stabilizers” because they react to changes in national income in a way that increases the federal deficit (or reduces the surplus) in the event of an economic contraction or reduces the deficit (increases the surplus) when the economy is expanding.

The automaticstabilizers make sure

that YD does notfall too much

when national incomeis falling

Automatic Stabilizers

Remember that the federaldeficit or surplus is

equal to the differencebetween G and Net Tax Receipts,

where Net Taxes are equal toTX - TR

YTX, for example

YTX, and vice versa

YTR, for example

YTR, and vice versaNote that claims for unemployment compensation and other assistance surges when unemployment rises.

National Income0

G, T Full-employment

G

T = TX - TR

YR

Deficit

YR is the recession-level of national income

Balanced budget at full-employment

Why a budget deficit has an expansionary effect on real GDP (income) and employment.

G

GDP (Income)

Remember that government expenditures are an injection and net takes are a leakage into the circular flow of economic activity.T

G

GDP (Income)

If, ceteris paribus, G > T, then real GDP and employment will expand—at least in the short run.

T

In the case of a federal deficit, the Treasury must borrow. The national debt

is the accumulated borrowing of thefederal government in all previous

fiscal years, minus what has been repaid

0

1

2

3

4

5

6

1865 1919 1946 1965 1980 1985 1993 1997

Trillions

The National debt, Selected years

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Is a large national debt a bad thing?

Arguments against a large national debt include:

•The “burden on future generations” argument.

•A large national debt means that a significant share of federal spending must be allocated for interest payments—leaving less for other priorities.

•A large national debt makes the U.S. too dependent on foreign financial inflows.

•Federal borrowing “crowds out” private sector borrowing units—i.e., firms and households.

“[W]e (the U.S.) owe $5.7 trillion in debt and if we don’t pay it off, our children and our grandchildren are going to have to.”

Congressman Marion Berry, in a speech to the Jonesboro Lions Club on April 16, 2001.

Interest as a Percent of Federal Outlays

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Year

20001995199019851980197519701965

Perc

ent

16

14

12

10

8

6

4

Who Owns the National Debt?

Source: Federal Reserve

3342 / 48%

463 / 7%

1271 / 18%

1814 / 26%

Privately Owned

Fed. Reserve Banks

Foreign Investors

Agencies and Trusts