Transcript
210Miller• Economics Today, Nineteenth Edition
Chapter 14Deficit Spending and the Public Debt209
Answers to Questions for Critical Analysis
Increasing Costs of Student Loan Forgiveness Are Raising Federal Budget Deficits (p. 306)
Who ultimately provides the funds to cover the expense of forgiving the qualifying portion of
U.S.-government-provided student loans?
Taxpayers are those who ultimately provide the funds to cover the expense of forgiving the qualifying portion of U.S. government-provided student loans.
Will Taxpayers Eventually Force Government Spending Cuts? (p. 307)
How might the fact that many people who vote in national elections pay very low or even no income taxes affect the capability of the political process to reduce government budget deficits?
Those voters can affect the election of legislative representatives and government officials who have control over government budget deficits.
What Nations’ Residents Have the Largest Holdings of the U.S. Public Debt? (p. 311)
Under what circumstance would the transfer of U.S. taxpayers’ funds to holder of U.S. debt residing in Japan and China constitute a “burden” on future generations of U.S. taxpayers? Explain briefly.
The debt must be repaid by U.S. taxpayers in the future, meaning that the debt constitutes a burden on future generations of U.S. taxpayers.
You Are There
Want A Balanced Budget? Sell Some Government Assets (p. 316)
1. Why do you suppose that governments do not rely on asset sales as a major revenue source over many years?
Most governments in the world do not have such real-estate assets as palaces for sale, as such properties are mostly privately-owned.
2. Why might nations’ governments earn lower-than-anticipated revenues from asset sales if all governments offered similar assets for sale simultaneously? (Hint: What would happen to asset supplies and market clearing prices if all governments sought to sell substantial numbers of the same types of assets?)
If all governments sought to sell substantial numbers of similar assets, their market clearing prices would fall as asset supplies would increase. As result, the revenues from those asset sales would fall.
Issues & Applications
Is Fiscal Policy Drowning in Accumulated Budgetary Red Ink? (pp. 316-317)
1. To which key set of expenditures do you suppose that “other things being equal” definitely applies in the government’s projections displayed in panel (b) of Figure 14-6? (Hint: Which types of expenses does the government often refer to as “noncontrollable”?).
The main type of expenditures that “other things being equal” applies to entitlements, including social security, Medicare, and Medicaid.
2. If the federal government were to try to borrow more in future years to expand its capability to boost discretionary spending what would likely happen to its net interest costs?
If the federal government were to try to borrow more in future years to expand its capability to boost discretionary spending, its net interest costs would increase as a result of a larger public debt.
Research Project
1. To review government budget projections, see the Web Links in MyEconLab.
2. For data on total interest paid on the gross government debt, see the Web Links in MyEconLab.
Answers to Problems
14-1. In 2019, government spending is $4.3 trillion, and taxes collected are $3.9 trillion. What is the federal government deficit in that year?
$0.4 trillion
14-2. Suppose that the Office of Management and Budget provides the estimates of federal budget receipts, federal budget spending, and GDP at the right, all expressed in billions of dollars. Calculate the implied estimates of the federal budget deficit as a percentage of
GDP for each year.
Federal Federal
Budget Budget
Year Receipts Spending GDP
2019 4,029.8 4,582.6 19,573.2
2020 4,102.4 4,641.6 20,316.0
2021 4,164.2 4,729.3 21,852.1
2022 4,113.5 4,800.1 22,454.4
2019: 2.82 percent
2020: 2.65 percent
2021: 2.59 percent
2022: 3.06 percent
14-3. It may be argued that the effects of a higher public debt are the same as the effects of a higher deficit. Why?
A higher deficit creates a higher public debt.
14-4. What happens to the net public debt if the federal government operates next year with the following:
a. A budget deficit?
b. A balanced budget?
c. A budget surplus?
a. Higher net public debt
b. Unchanged net public debt
c. Lower net public debt
14-5. What is the relationship between the gross public debt and the net public debt?
The net public debt is obtained by subtracting government interagency borrowing from the gross public debt.
14-6. Explain how each of the following will affect the net public debt, other things being equal.
a. Previously, the government operated with a balanced budget, but recently there has been a sudden increase in federal tax collections.
b. The government had been operating with a very small annual budget deficit until three hurricanes hit the Atlantic Coast, and now government spending has risen substantially.
c. The Government National Mortgage Association, a federal government agency that purchases certain types of home mortgages, buys U.S. Treasury bonds from another government agency.
a. The government will operate with a budget surplus during the present year, which will cause the net public debt to decrease.
b. The net public debt, which had been rising slowly as a result of previously small annual deficits, will now rise more rapidly due to a sharply higher deficit this year.
c. This transfer of government debt among agencies of the government leaves the amount held by the public unaffected, so the net public debt remains unchanged.
14-7. Explain in your own words why there is likely to be a relationship between federal budget deficits and U.S. international trade deficits.
When foreign dollar holders hold more domestic government bonds issued to finance higher domestic government budget deficits, they purchase fewer domestic exports, so the domestic trade deficit rises, other things being equal.
14-8. Suppose that the share of U.S. GDP going to domestic consumption remains constant. Initially, the federal government was operating with a balanced budget, but this year it
has increased its spending well above its collections of taxes and other sources of revenues. To fund its deficit spending, the government has issued bonds. So far, very few foreign residents have shown any interest in purchasing the bonds.
a. What must happen to induce foreign residents to buy the bonds?
b. If foreign residents desire to purchase the bonds, what is the most important source of dollars to buy them?
a. Other things being equal, foreign dollar holders can be induced to hold more U.S. government bonds used to finance domestic government deficits only if the interest rate paid on U.S. government bonds rises.
b. Immediately, the main source of dollars are the dollars that foreign residents otherwise would use to purchase exports.
14-9. Suppose that the economy is experiencing the short-run equilibrium position depicted at point A in the diagram below. Then the government raises its spending and thereby runs a budget deficit in an effort to boost equilibrium real GDP to its long-run equilibrium level
of $18 trillion (in base-year dollars). Explain the effects of an increase in the government deficit on equilibrium real GDP and the equilibrium price level. In addition, given that many taxes and government benefits vary with real GDP, discuss what change we might expect to see in the budget deficit as a result of the effects on equilibrium real GDP.
As shown in the diagram below, the increase in government spending and/or tax reduction that creates the budget deficit also causes the aggregate demand curve to shift rightward, from AD to AD2. Real GDP rises to its long-run equilibrium level of $18 trillion at point B. The equilibrium price level increases to a value of 130 at this point. As real GDP rises, the government’s tax collections increase and payouts of income transfer payments fall, both of which will help ultimately reduce the deficit.
14-10. Suppose that the economy is experiencing the short-run equilibrium position depicted
at point B in the diagram below. Explain the short-run effects of an increase in the government deficit on equilibrium real GDP and the equilibrium price level. What will be the long-run effects?
As shown in the diagram below, the increase in government spending and/or tax reduction that creates the budget deficit also causes the aggregate demand curve to shift rightward, from AD to AD2. With unchanged short-run aggregate supply, a new short-run equilibrium is reached at point C. The equilibrium price level rises to a value such as 130, and equilibrium real GDP increases to a level such as $20 trillion per year. Ultimately, however, upward adjustments in wages and other input prices will induce a leftward shift in the SRAS curve to SRAS2, resulting in a new long-run equilibrium at point D. In the long run, the price level will rise further, to a value such as 133, and real GDP will return to $18.5 trillion.
14-11. To eliminate the deficit (and halt the growth of the net public debt), a politician suggests that “we should tax the rich.” The politician makes a simple arithmetic calculation in which he applies a higher tax rate to the total income reported by “the rich” in a previous year. He says that the government could thereby solve the deficit problem by taxing “the rich.” What is the major fallacy in such a claim?
“The rich” are likely to respond to higher tax rates by reducing their activities that generate taxable income, so actual tax collections from “the rich” will not turn out to be as high as the politician suggests.
14-12. Refer back to Problem 14-11. If the politician defines “the rich” as people with annual taxable incomes exceeding $1 million per year, what is another difficulty with the politician’s reasoning, given that “the rich” rarely earn a combined taxable income exceeding $1 trillion, yet the federal deficit has regularly exceeded $1 trillion in recent years?
Even confiscating the total taxable income typically earned each year by “the rich” typically would not be sufficient to pay off the deficit. Raising income tax rates for “the rich” is an alternative to confiscation, and this action would only slightly reduce the deficit.
14-13. In each of the past few years, the federal government has regularly borrowed funds to pay for at least one-third of expenditures that tax revenues were insufficient to cover. More than 60 percent of all federal expenditures now go for entitlement spending. What does this fact imply about how the government is paying for most of its discretionary expenditures?
These data indicate that tax revenues have been able to cover only about two-thirds—about
67 percent—of federal expenditures. Because more than 60 percent of all federal expenditures
are entitlements, this implies that the federal government has been borrowing to pay for most discretionary spending.
14-14. Take a look at Figure 14-1. During the brief green-shaded intervals, is the amount of the U.S. net public debt more likely to be increasing or decreasing? Explain your reasoning.
The green-shaded intervals are periods during which the government operated with budget surpluses in which it has collected more tax revenues than its expenditures. Consequently, the government did not add to its indebtedness during these periods. As long as the government was continuing to make interest and principal payments to the holders of its debts, the net public debt decreased during these intervals.
14-15. Consider Figure 14-2. The years immediately after 2008 stand out as having the highest values in the figure. The main reason is that the dollar magnitudes of the federal government’s deficits were very large during these years. How might the fact that a significant economic contraction occurred during these years provide another explanation for why the percentages for these years were so high?
The deficit-to-GDP percentage is equal to 100 times the deficit divided by GDP. During an economic contraction, real GDP falls below the long-run level consistent with LRAS curve. Consequently, the ratio used to compute the percentages in the figure declines during contraction periods, which helps to push up the percentages somewhat.
14-16. Take a look at the most recent years of data on the net public debt displayed in Figure 14-3, and then examine the most recent years of data on federal budget deficits shown in
Figure 14-2. Why do you suppose that the net public debt as a percentage of GDP has grown more slowly recently than was the case between 2008 and 2015?
Recall that federal deficits are added each year to the stock of the net public debt. As deficits have declined in relation to GDP in recent years, therefore, the amounts added to the net public debt also have decreased, which has caused the net public debt as a percentage of GDP to grow at a slower pace.
14-17. A fraction of the funds borrowed by the federal government between 2008 and 2015
were utilized to fund public investments in a number of solar power companies that produced little output and halted operations. These concerns provided no repayments
to the government. In what sense might this fraction of deficit spending arguably have imposed a “burden” on future generations?
This spending of borrowed funds failed to contribute to future increases in real GDP, so future generations will have to be taxed at least at a slightly higher rate than otherwise would have been required.
14-18. Consider Figure 14-4, which shows that trade deficits usually accompany federal budget deficits. Explain why we might anticipate that federal budget deficits and trade deficits would tend to be related?
There are two ways that government budget deficits are directly related to trade deficits. The
first link is that a government budget deficit can be financed by funds of residents from abroad. The second link comes from the fact that increased borrowing by the government to finance its deficits will raise interest rates on new government bonds. When foreigners purchase those bonds, they have fewer dollars to spend on U.S. export goods.
14-19. The long-run effect of higher government budget deficits on the equilibrium annual flow of real GDP is zero. Who, therefore, benefits in the long run from higher government deficits?
Those who benefit in the long run from higher budget deficits are those who receive the larger share of the annual flow of real GDP to government-provided goods and services—that is, those to whom these goods and services are redistributed.
Selected References
Buchanan, James M. and Richard E. Wagner, Democracy in Deficit, New York: Academic Press, 1977.
Eisner, Robert and Paul Pieper, “A New View of Federal Debt and Budget Deficits,” American Economic Review, March 1984, pp. 11–29.
Ferguson, James M., ed., Public Debt and Future Generations, Chapel Hill: University of North Carolina Press, 1964.
Friedman, Milton, Essays in Positive Economics, Chicago: Chicago University Press, 1966.
Gordon, Robert J., Macroeconomics, 9th ed., Boston: Addison-Wesley, 2003.
Hoover, Kevin D. and Joseph R. Bisignano, “Classical Reflections on the Deficit,” in Ben Bernanke, ed., Readings and Cases in Macroeconomics, New York: McGraw-Hill, 1987.
Miller, Roger L. and David D. VanHoose, Modern Money and Banking, 3rd ed., New York: McGraw-Hill, 1993.
Mishkin, Frederic S., The Economics of Money, Banking, and Financial Markets, Boston: Addison-Wesley, 2006.
Suits, Daniel B. and Ronald C. Fisher, “A Balanced Budget Amendment: Economic Complexities and Uncertainties,” National Tax Journal, December 1985, pp. 467–477.
