Deck 12: Federal Budgets and Public Policy

Question 1

Outline what has happened to the federal debt in recent decades and how it compares with debt levels in other countries
(Debt Measures) What's the difference between gross federal debt and federal debt held by the public?

Answer 1

Gross Federal Debt
Gross federal debt includes US Treasury Securities held by households, foreign institutions or entities, firms, and banks as well as by various federal agencies.
US treasury securities held by Federal Reserve banks are also taken as part of gross federal debt.
Gross federal debt includes debt that US government owed to itself as well as to outsiders.
Federal Debt Held by the Public
Federal debt held by the public includes US treasury securities as held by the foreign institutions or entities, general public, business firms, and banks.
Banks here includes Federal Reserve Banks as well.
Federal debt held by the public is part of the gross federal debt.
Federal debt held by the public includes debt that US government owed to outsiders only.

Question 2

THE NATIONAL DEBT Try the following exercises to better understand how the national debt is related to the government's budget deficit.
a. Assume that the gross national debt initially is equal to $3 trillion and the federal government then runs a deficit of $300 billion:
i. What is the new level of gross national debt?
ii. If 100 percent of the deficit is financed by the sale of securities to federal agencies, what happens to the amount of debt held by the public? What happens to the level of gross debt?
iii. If GDP increased by 5 percent in the same year that the deficit is run, what happens to gross debt as a percentage of GDP? What happens to the level of debt held by the public as a percentage of GDP?
b. Now suppose that the gross national debt initially is equal to $2.5 trillion and the federal government then runs a deficit of $100 billion:
i. What is the new level of gross national debt?
ii. If 100 percent of this deficit is financed by the sale of securities to the public, what happens to the level of debt held by the public? What happens to the level of gross debt?
iii. If GDP increases by 6 percent in the same year as the deficit is run, what happens to gross debt as a percentage of GDP? What happens to the level of debt held by the public as a percentage of GDP?

Answer 2

Impact of national debt on budget deficit:
a. Assume that national debt of a country is $3 trillion with fiscal deficit of $300 billion.
i.
The present budget deficit of $300 billion will be added to the gross national debt; hence, the gross national debt at the end of the year will be .
ii.
Government would plan to finance the 100 percent of deficit by selling securities to the federal agency; hence, the debt held by public will remain unchanged. This is because the additional debt burden will not be borne by the public.
The gross national debt at the end of the year will be , because the government has to purchase the sold securities from the federal agency.
iii.
Since $300 billion increase in budget deficit will be added to the national debt, the gross national debt will increase by 10 percent. At the same time, GDP of the country will increase by only 5 percent; hence, the debt share to the GDP has increased.
Since the GDP of the country increased by only 5 percent, the debt held by public remains same; hence, share of debt held by public to the GDP will fall.
b. Assume that national debt of a country is $2.5 trillion with fiscal deficit of $100 billion.
i.
The present budget deficit of $300 billion will be added to the gross national debt; hence, the gross national debt at the end of the year will be .
ii.
Government would plan to finance the 100 percent of deficit by selling securities to the public; hence, the debt held by public will increase by . This is because the additional debt burden will be borne by the public.
The gross national debt at the end of the year will rise by , because the government has to purchase the sold securities from the public.
iii.
Since $100 billion increase in budget deficit will be added to the national debt, the gross national debt will increase by 4 percent. At the same time, GDP of the country will increase by only 6 percent; thereby, percentage share of debt to GDP will decrease.
GDP of the country increased by only 6 percent and debt held by public is increased by 4 percent; hence, percentage share of public debt to GDP will decrease.

Question 3

CROWDING OUT AND CAPITAL FORMATION In earlier chapters, we've seen that the government can try to increase GDP in the short run by running a budget deficit. What are some long-term effects of deficit spending?

Answer 3

Long-term effect of deficit budget:
The long-term effect of deficit budget depends on the nature of government spending. If the government outlays are invested productively in development of infrastructure like highways and bridge and development of human capital like spending in health and education , then it will have a positive effect on economic growth in the long term.
If the government outlays are spent on current expenditures like farm subsidies or higher retirement benefits and unemployment quota, then it will harm the economic growth in the long term.

Question 4

SUSTAINABILITY OF FEDERAL DEBT Are large federal deficits and a growing federal debt sustainable? What can be learned from the experiences of other countries?

Question 5

Summarize how federal spending priorities have changed since the 1960s
(Changing Budget Priorities) What spending category claimed the largest share of federal outlays during the 1960s? How about during the most recent decade?

Question 6

Summarize how federal spending priorities have changed since the 1960s
(The Federal Budget Process) Why does the budget require a forecast of the economy? Under what circumstances would actual government spending and tax revenue fail to match the budget as approved?

Question 7

BUDGET PHILOSOPHIES Explain the differences among an annually balanced budget, a cyclically balanced budget, and functional finance. How does each affect economic fluctuations?

Question 8

Explain why the federal budget been in deficit in most years since the Great Depression
(Chronic Deficits) Why has the federal budget been in deficit in all but 14 years since 1929?

Question 9

Outline what has happened to the federal debt in recent decades and how it compares with debt levels in other countries
(Federal Debt) What has happened to the federal debt since 2008 as measured relative to GDP?

Question 10

Outline what has happened to the federal debt in recent decades and how it compares with debt levels in other countries
(Net Public Debt) What's the level of net public debt (for federal, state, and local governments) relative to U.S. GDP? How does the U.S. measure compare with that of other major economies?