Long-Run Implications of Fiscal Policy

In 2009 the government of Greece ran into a financial wall. Like most other governments in Europe (and the U.S. government, too), the Greek government was running a large budget deficit, which meant that it needed to keep borrowing more funds, both to cover its expenses and to pay off existing loans as they came due. But governments, like companies or individuals, can only borrow if lenders believe there’s a good chance they are willing or able to repay their debts. By 2009 most investors, having lost confidence in Greece’s financial future, were no longer willing to lend to the Greek government. Those few who were willing to lend demanded very high interest rates to compensate them for the risk of loss.

Figure 15-10 compares interest rates on 10-year bonds issued by the governments of Greece and Germany. At the beginning of 2007, Greece could borrow at almost the same rate as Germany, widely considered a very safe borrower. By the end of 2011, however, Greece was having to pay an interest rate around 10 times the rate Germany paid.

Greek and German Long-Term Interest Rates As late as 2008, the government of Greece could borrow at interest rates only slightly higher than those facing Germany, widely considered a very safe borrower. But in early 2009, as it became clear that both Greek debt and Greek deficits were larger than previously reported, investors lost confidence, sending Greek borrowing costs sky-high.
Source: European Central Bank.
Greeks angered by their government’s harsh austerity measures took to the streets in protest.
Aris Messinis/AFP/Getty Images

Why was Greece having these problems? Largely because investors had become deeply worried about the level of its debt (in part because it became clear that the Greek government had been using creative accounting to hide just how much debt it had already taken on). Government debt is, after all, a promise to make future payments to lenders. By 2009 it seemed likely that the Greek government had already promised more than it could possibly deliver.

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The result was that Greece found itself unable to borrow more from private lenders; it received emergency loans from other European nations and the International Monetary Fund, but these loans came with the requirement that the Greek government make severe spending cuts, which wreaked havoc with its economy, imposed severe economic hardship on Greeks, and led to massive social unrest.

No discussion of fiscal policy is complete if it doesn’t take into account the long-run implications of government budget surpluses and deficits, especially the implications for government debt. We now turn to those long-run implications.

Deficits, Surpluses, and Debt

When a family spends more than it earns over the course of a year, it has to raise the extra funds either by selling assets or by borrowing. And if a family borrows year after year, it will eventually end up with a lot of debt.

The same is true for governments. With a few exceptions, governments don’t raise large sums by selling assets such as national parkland. Instead, when a government spends more than the tax revenue it receives—when it runs a budget deficit—it almost always borrows the extra funds. And governments that run persistent budget deficits end up with substantial debts.

A fiscal year runs from October 1 to September 30 and is labeled according to the calendar year in which it ends.

To interpret the numbers that follow, you need to know a slightly peculiar feature of federal government accounting. For historical reasons, the U.S. government does not keep books by calendar years. Instead, budget totals are kept by fiscal years, which run from October 1 to September 30 and are labeled by the calendar year in which they end. For example, fiscal 2010 began on October 1, 2009, and ended on September 30, 2010.

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Deficits Versus Debt

One common mistake—it happens all the time in newspaper reports—is to confuse deficits with debt. Let’s review the difference.

A deficit is the difference between the amount of money a government spends and the amount it receives in taxes over a given period—usually, though not always, a year. Deficit numbers always come with a statement about the time period to which they apply, as in “the U.S. budget deficit in fiscal 2012 was $1.1 trillion.”

A debt is the sum of money a government owes at a particular point in time. Debt numbers usually come with a specific date, as in “U.S. public debt at the end of fiscal 2012 was $11.3 trillion.”

Deficits and debt are linked, because government debt grows when governments run deficits. But they aren’t the same thing, and they can even tell different stories. For example, Italy, which found itself in debt trouble in 2011, had a fairly small deficit by historical standards, but it had very high debt, a legacy of past policies.

Public debt is government debt held by individuals and institutions outside the government.

At the end of fiscal 2012, the U.S. federal government had total debt equal to $16.1 trillion. However, part of that debt represented special accounting rules specifying that the federal government as a whole owes funds to certain government programs, especially Social Security. We’ll explain those rules shortly. For now, however, let’s focus on public debt: government debt held by individuals and institutions outside the government. At the end of fiscal 2012, the federal government’s public debt was “only” $11.3 trillion, or 72% of GDP. If we include the debts of state and local governments, total public debt at the end of fiscal 2012 was larger than it was at the end of fiscal 2011 because the federal government ran a budget deficit during fiscal 2012. A government that runs persistent budget deficits will experience a rising level of public debt. Why is this a problem?

The American Way of Debt

How does the public debt of the United States stack up internationally? In dollar terms, we’re number one—but this isn’t very informative, since the U.S. economy and so the government’s tax base are much larger than those of any other nation. A more informative comparison is the ratio of public debt to GDP.

The figure shows the net public debt of a number of rich countries as a percentage of GDP at the end of 2011. Net public debt is government debt minus any assets governments may have—an adjustment that can make a big difference. What you see here is that the United States is more or less in the middle of the pack.

It may not surprise you that Greece heads the list, and most of the other high net debt countries are European nations that have been making headlines for their debt problems. Interestingly, however, Japan is also high on the list because it used massive public spending to prop up its economy in the 1990s. Investors, however, still consider Japan a reliable government, so its borrowing costs remain low despite high net debt.

In contrast to the other countries, Norway has a large negative net public debt. What’s going on in Norway? In a word, oil. Norway is the world’s third-largest oil exporter, thanks to large offshore deposits in the North Sea. Instead of spending its oil revenues immediately, the government of Norway has used them to build up an investment fund for future needs following the lead of traditional oil producers like Saudi Arabia. As a result, Norway has a huge stock of government assets rather than a large government debt.

Source: International Monetary Fund.

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Problems Posed by Rising Government Debt

There are two reasons to be concerned when a government runs persistent budget deficits. When the economy is at full employment and the government borrows funds in the financial markets, it is competing with firms that plan to borrow funds for investment spending. As a result, the government’s borrowing may crowd out private investment spending, increasing interest rates and reducing the economy’s long-run rate of growth.

But there’s a second reason: today’s deficits, by increasing the government’s debt, place financial pressure on future budgets. The impact of current deficits on future budgets is straightforward. Like individuals, governments must pay their bills, including interest payments on their accumulated debt. When a government is deeply in debt, those interest payments can be substantial. In fiscal 2011, the U.S. federal government paid 1.8% of GDP—$266 billion—in interest on its debt. The more heavily indebted government of Italy paid interest of 4.7% of its GDP in 2011.

Other things equal, a government paying large sums in interest must raise more revenue from taxes or spend less than it would otherwise be able to afford—or it must borrow even more to cover the gap. And a government that borrows to pay interest on its outstanding debt pushes itself even deeper into debt. This process can eventually push a government to the point where lenders question its ability to repay. Like a consumer who has maxed out his or her credit cards, it will find that lenders are unwilling to lend any more funds. The result can be that the government defaults on its debt—it stops paying what it owes. Default is often followed by deep financial and economic turmoil.

Americans aren’t used to the idea of government default, but such things do happen. In the 1990s Argentina, a relatively high-income developing country, was widely praised for its economic policies—and it was able to borrow large sums from foreign lenders. By 2001, however, Argentina’s interest payments were spiraling out of control, and the country stopped paying the sums that were due. In the end, it reached a settlement with most of its lenders under which it paid less than a third of the amount originally due. By late 2011 investors were placing a fairly high probability on Argentine-type default by several European countries—namely, Greece, Ireland, and Portugal—and were seriously worried about Italy and Spain. Each one was forced to pay high interest rates on its debt by nervous lenders, exacerbating the risk of default.

Default creates havoc in a country’s financial markets and badly shakes public confidence in both the government and the economy. Argentina’s debt default was accompanied by a crisis in the country’s banking system and a very severe recession. And even if a highly indebted government avoids default, a heavy debt burden typically forces it to slash spending or raise taxes, politically unpopular measures that can also damage the economy. In some cases, “austerity” measures intended to reassure lenders that the government can indeed pay end up depressing the economy so much that lender confidence continues to fall—a process we’ll look at more closely in the Economics in Action that follows this section.

Some may ask why can’t a government that has trouble borrowing just print money to pay its bills? Yes, it can if it has its own currency (which the troubled European nations don’t). But printing money to pay the government’s bills can lead to another problem: inflation. In fact, budget problems are the main cause of very severe inflation. The point for now is that governments do not want to find themselves in a position where the choice is between defaulting on their debts and inflating those debts away by printing money.

Concerns about the long-run effects of deficits need not rule out the use of expansionary fiscal policy to stimulate the economy when it is depressed. However, these concerns do mean that governments should try to offset budget deficits in bad years with budget surpluses in good years. In other words, governments should run a budget that is approximately balanced over time. Have they actually done so?

470

Deficits and Debt in Practice

Figure 15-11 shows how the U.S. federal government’s budget deficit and its debt evolved from 1940 to 2011. Panel (a) shows the federal deficit as a percentage of GDP. As you can see, the federal government ran huge deficits during World War II. It briefly ran surpluses after the war, but it has normally run deficits ever since, especially after 1980. This seems inconsistent with the advice that governments should offset deficits in bad times with surpluses in good times.

U.S. Federal Deficits and Debt Panel (a) shows the U.S. federal budget deficit as a percentage of GDP from 1940 to 2011. The U.S. government ran huge deficits during World War II and has run smaller deficits ever since. Panel (b) shows the U.S. debt–GDP ratio. Comparing panels (a) and (b), you can see that in many years the debt–GDP ratio has declined in spite of government deficits. This seeming paradox reflects the fact that the debt–GDP ratio can fall, even when debt is rising, as long as GDP grows faster than debt.
Source: Office of Management and Budget.

The debt–GDP ratio is the government’s debt as a percentage of GDP.

However, panel (b) of Figure 15-11 shows that for most of the period these persistent deficits didn’t lead to runaway debt. To assess the ability of governments to pay their debt, we use the debt–GDP ratio, the government’s debt as a percentage of GDP. We use this measure, rather than simply looking at the size of the debt, because GDP, which measures the size of the economy as a whole, is a good indicator of the potential taxes the government can collect. If the government’s debt grows more slowly than GDP, the burden of paying that debt is actually falling compared with the government’s potential tax revenue.

What we see from panel (b) is that although the federal debt grew in almost every year, the debt–GDP ratio fell for 30 years after the end of World War II. This shows that the debt–GDP ratio can fall, even when debt is rising, as long as GDP grows faster than debt. For Inquiring Minds, which focuses on the large debt the U.S. government ran up during World War II, explains how growth and inflation sometimes allow a government that runs persistent budget deficits to nevertheless have a declining debt–GDP ratio.

471

What Happened to the Debt from World War II?

As you can see from Figure 15-11, the U.S. government paid for World War II by borrowing on a huge scale. By the war’s end, the public debt was more than 100% of GDP, and many people worried about how it could ever be paid off.

The truth is that it never was paid off. In 1946 public debt was $242 billion; that number dipped slightly in the next few years, as the United States ran postwar budget surpluses, but the government budget went back into deficit in 1950 with the start of the Korean War. By 1962 the public debt was back up to $248 billion.

But by that time nobody was worried about the fiscal health of the U.S. government because the debt–GDP ratio had fallen by more than half. The reason? Vigorous economic growth, plus mild inflation, had led to a rapid rise in GDP. The experience was a clear lesson in the peculiar fact that modern governments can run deficits forever, as long as they aren’t too large.

Still, a government that runs persistent large deficits will have a rising debt–GDP ratio when debt grows faster than GDP. In the aftermath of the financial crisis of 2008, the U.S. government began running deficits much larger than anything seen since World War II, and the debt–GDP ratio began rising sharply. Similar surges in the debt–GDP ratio could be seen in a number of other countries in 2008. Economists and policy makers agreed that this was not a sustainable trend, that governments would need to get their spending and revenues back in line. But when to bring spending in line with revenue was a source of great disagreement. Some argued for fiscal tightening right away; others argued that this tightening should be postponed until the major economies had recovered from their slump.

Implicit Liabilities

Implicit liabilities are spending promises made by governments that are effectively a debt despite the fact that they are not included in the usual debt statistics.

Looking at Figure 15-11, you might be tempted to conclude that until the 2008 crisis struck, the U.S. federal budget was in fairly decent shape: the return to budget deficits after 2001 caused the debt–GDP ratio to rise a bit, but that ratio was still low compared with both historical experience and some other wealthy countries. In fact, however, experts on long-run budget issues view the situation of the United States (and other countries such as Japan and Italy) with alarm. The reason is the problem of implicit liabilities. Implicit liabilities are spending promises made by governments that are effectively a debt despite the fact that they are not included in the usual debt statistics.

The largest implicit liabilities of the U.S. government arise from two transfer programs that principally benefit older Americans: Social Security and Medicare. The third-largest implicit liability, Medicaid, benefits low-income families. In each of these cases, the government has promised to provide transfer payments to future as well as current beneficiaries. So these programs represent a future debt that must be honored, even though the debt does not currently show up in the usual statistics. Together, these three programs currently account for almost 40% of federal spending.

The implicit liabilities created by these transfer programs worry fiscal experts. Figure 15-12 shows why. It shows actual spending on Social Security and on Medicare, Medicaid, and CHIP (a program that provides health care coverage to uninsured children) as percentages of GDP from 2000 to 2010, together with Congressional Budget Office projections of spending through 2085. According to these projections, spending on Social Security will rise substantially over the next few decades and spending on the three health care programs will soar. Why?

Future Demands on the Federal Budget This figure shows Congressional Budget Office projections of spending on social insurance programs as a share of GDP. Partly as a result of an aging population, but mainly because of rising health care costs, these programs are expected to become much more expensive over time, posing problems for the federal budget.
Source: Congressional Budget Office.

In the case of Social Security, the answer is demography. Social Security is a “pay-as-you-go” system: current workers pay payroll taxes that fund the benefits of current retirees. So the ratio of the number of retirees drawing benefits to the number of workers paying into Social Security has a major impact on the system’s finances. There was a huge surge in the U.S. birth rate between 1946 and 1964, the years of what is commonly called the “baby boom.” Most baby boomers are currently of working age—which means they are paying taxes, not collecting benefits. But some are starting to retire, and as more and more of them do so, they will stop earning taxable income and start collecting benefits. As a result, the ratio of retirees receiving benefits to workers paying into the Social Security system will rise. In 2010 there were 34 retirees receiving benefits for every 100 workers paying into the system. By 2030, according to the Social Security Administration, that number will rise to 46; by 2050, it will rise to 48; and by 2080, that number will be 51. So as baby boomers move into retirement, benefit payments will continue to rise relative to the size of the economy.

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The aging of the baby boomers, by itself, poses only a moderately sized long-run fiscal problem. The projected rise in Medicare and Medicaid spending is a much more serious concern. The main story behind projections of higher Medicare and Medicaid spending is the long-run tendency of health care spending to rise faster than overall spending, both for government-funded and for privately funded health care.

To some extent, the implicit liabilities of the U.S. government are already reflected in debt statistics. We mentioned earlier that the government had a total debt of $16.1 trillion at the end of fiscal 2012 but that only $11.3 trillion of that total was owed to the public. The main explanation for that discrepancy is that both Social Security and part of Medicare (the hospital insurance program) are supported by dedicated taxes: their expenses are paid out of special taxes on wages. At times, these dedicated taxes yield more revenue than is needed to pay current benefits. In particular, since the mid-1980s the Social Security system has been taking in more revenue than it currently needs in order to prepare for the retirement of the baby boomers. This surplus in the Social Security system has been used to accumulate a Social Security trust fund, which was about $3 trillion at the end of fiscal 2012.

The money in the trust fund is held in the form of U.S. government bonds, which are included in the $16.1 trillion in total debt. You could say that there’s something funny about counting bonds in the Social Security trust fund as part of government debt. After all, these bonds are owed by one part of the government (the government outside the Social Security system) to another part of the government (the Social Security system itself). But the debt corresponds to a real, if implicit, liability: promises by the government to pay future retirement benefits. So many economists argue that the gross debt of $16.1 trillion, the sum of public debt and government debt held by Social Security and other trust funds, is a more accurate indication of the government’s fiscal health than the smaller amount owed to the public alone.

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Austerity Dilemmas

Suppose that a country’s economy hits a rough patch and lenders worry if the government, already deeply indebted, will be able to repay its loans. As a result, lenders cut off further lending. What’s a government to do?

The usual prescription has been fiscal austerity: cut government spending and raise taxes, to both reduce the need to borrow more funds and to demonstrate to lenders the ability and determination to do what’s necessary to honor its debts. But besides being painful and politically unpopular, does fiscal austerity really work to extricate a country from a crisis of lender confidence? Both economics and history indicate that the likely answer is no.

Fiscal austerity means contractionary fiscal policy. And we know from our earlier analysis that if an economy is already depressed, contractionary fiscal policy will depress it further. Moreover, the experiences of Argentina and Ireland show that the worsened state of an economy arising from austerity can further undermine the lender confidence that it was supposed to support.

Argentina presents a clear picture of the dynamic. Starting in the 1990s, Argentina was a favorite of foreign lenders and borrowed freely from abroad. But its debts accumulated, and by the late 2000s when the economy hit a downturn, lenders began to get worried. From 1997 to 2001, Argentina tried to reassure lenders that it was credit-worthy by repeatedly raising taxes and cutting government spending. But each round of austerity so weakened the economy that the government was unable to balance its budget. Finally, facing massive popular protests, the government collapsed and defaulted on its debts.

Since 2009, Ireland has gone through a similar experience, although the origins of its troubles were different. Until 2008, Ireland’s government ran a more or less balanced budget. But during the 2000s, the Irish economy had a massive real estate bubble, fueled by excessive bank lending to real estate developers. When the bubble burst, Irish banks were left with massive losses. In order to prop them up, the Irish government guaranteed the banks’ losses, making Irish taxpayers responsible for paying off the banks’ debts. But, as it turns out, these debts were so large that the government’s own solvency came into question, and the interest rate at which it had to borrow rose abruptly. This result can be seen in Figure 15-13, which shows how the interest rate spread between Irish government bonds and German government bonds (which are considered very safe) jumped in late 2008 and early 2009.

Interest Rates on Irish and German Bonds
Source: European Central Bank.

In an attempt to regain lender confidence, Ireland imposed severe austerity, even though the economy had already fallen into recession. For example, the government adopted a policy of reducing its workforce by 25,000; calculated as a percentage of the population, this was equivalent to a loss of 2.5 million jobs in the United States.

By mid-2010, the Irish austerity policy appeared to be working, as rates on Irish bonds stabilized and even fell a bit from 2009 to 2010. But by 2011, it all fell apart as the size of the banks’ losses continued to mushroom and it became clear that the austerity policies were pushing the economy deeper into a recession. By late 2010, Irish GDP was 12% lower than it had been at the end of 2007, with very little growth in 2011 or 2012. The weaknesses of the Irish economy were depressing tax revenues, undoing much of the direct effect of austerity. Simultaneously, the decline in GDP had contributed to a surge in the debt–GDP ratio.

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So why do lenders advocate, and indebted countries adopt, such self-defeating austerity measures? Because they make the mistake of thinking that an economy is like a household: if the family would just cut back on their spending, so the thinking goes, then they could pay their credit card bills. But as we know, an economy is not like a family; instead, one person’s spending is another person’s income. So austerity measures that reduce spending end up reducing income and making it even less likely that a country can repay its debts.

Quick Review

  • Persistent budget deficits lead to increases in public debt.
  • Rising public debt can lead to government default. In less extreme cases, it can crowd out investment spending, reducing long-run growth. This suggests that budget deficits in bad fiscal years should be offset with budget surpluses in good fiscal years.
  • A widely used indicator of fiscal health is the debt–GDP ratio. A country with rising GDP can have a stable or falling debt–GDP ratio even if it runs budget deficits if GDP is growing faster than the debt.
  • In addition to their official public debt, modern governments have implicit liabilities. The U.S. government has large implicit liabilities in the form of Social Security, Medicare, and Medicaid.

Check Your Understanding 15-4

    • Question

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      A higher growth rate of real GDP implies that tax revenue will increase. If government spending remains constant and the government runs a budget surplus, the size of the public debt will be less than it would otherwise have been.
    • Question

      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
      If retirees live longer, the average age of the population increases. As a result, the implicit liabilities of the government increase because spending on programs for older Americans, such as Social Security and Medicare, will rise.
    • Question

      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
      A decrease in tax revenue without offsetting reductions in government spending will cause the public debt to increase.
    • Question

      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
      Public debt will increase as a result of government borrowing to pay interest on its current public debt.
  1. Question

    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
    In order to stimulate the economy in the short run, the government can use fiscal policy to increase real GDP. This entails borrowing, increasing the size of the public debt further and leading to undesirable consequences: in extreme cases, governments can be forced to default on their debts. Even in less extreme cases, a large public debt is undesirable because government borrowing “crowds out” borrowing for private investment spending. This reduces the amount of investment spending, reducing the longrun growth of the economy.
  2. Question

    TbnQKQ0IVzNKRjRYJNmH3bxM0sI6MpmfktLiI7BJ6ezehoLIdYnQJiXoUDNXiV/bb2PjGYQfpzvwgj3v5MTQL0cTHyd60yG2Dm8Hc6QGmhY4E4E3legNkzhJ935UtDJ7jqGlS1Jqs4iDLUMRAJbn2zEmRlUsnv0S4wBuK6Ndk2G85fycC0/lwE0DDeEryIt3jW0zlA==
    Fiscal austerity is the same as a contractionary fiscal policy. It reduces government spending, which in turn reduces income and reduces tax revenue. With less tax revenue, the government is less able to pay its debts. Also, a failing economy causes lenders to have less confidence that a government is able to pay its debts and leads them to raise interest rates on the debt. Higher interest rates on the debt make it even less likely the government can repay

Solutions appear at back of book.