Deck 17: Deficits and Debt

Question 1

How is government debt different from an individual's debt? Provide three reasons.

Answer 1

Government is perpetual.Unlike individuals,government does not have a finite life span,so there is no final settlement of accounts.Second,government has a power to meet its debts that individuals do not have: the power to print money.Third,for governments,the distinction between internal and external debt is significant.Internal debt is debt owed to the government's own citizens.It can be met by transfers from citizen taxpayers to citizen creditors (such that resources are not sent outside the country).Individuals can only have external debt.(LO4)

Question 2

What are two ways growth in GDP reduces the problems posed by deficits and debt? Explain each of them.

Answer 2

GDP can grow because of real growth or because of inflation.Real growth means that an economy is becoming wealthier.A wealthier economy has a greater ability to pay off a debt and is better able to carry a higher deficit.Consider the deficit in terms of deficit-to-GDP ratio.If a growing economy did not increase its deficit,the deficit-to-GDP ratio would decline.A continual and growing deficit in a growing economy is consistent with a constant deficit-to-GDP ratio,and to the extent that this measures the ability of a country to handle its deficit,a growing economy can increase its deficit comfortably.The second reason for nominal GDP growth is inflation.Inflation allows a country to increase its deficit because inflation wipes out debt.How? During a period of inflation,the country will be able to repay the debt with money of lesser value.To take this into account,economists have defined a real deficit (nominal deficit adjusted for the effect of inflation on the debt).A country that has inflation,then,can run a continual and rising deficit and,at the same time,keep its real deficit constant.(Note: this assumes interest payments on the debt do not rise with inflation).(LO4)

Question 3

Define the terms deficit and debt.Which is a flow concept and which is a stock concept?

Answer 3

A deficit is a shortfall of revenues below payments.A deficit occurs when spending exceeds revenues.Debt is accumulated deficits minus accumulated surpluses.The deficit is a flow concept,while debt is a stock concept.

Question 4

Define deficit and surplus.

Question 5

What is the difference between a passive deficit or surplus and the structural deficit or surplus?

Question 6

What's the difference between a structural and a passive budget deficit? What contributes to a passive deficit? For each of the following state what is happening to the structural and passive budget deficits:
(a)Economy is experiencing an expansion.
(b)Economy is experiencing a recession.
(c)Economy is growing at its long-term secular growth rate.
(d)The potential level of output declines while equilibrium output remains unchanged.

Question 7

Why do economists prefer to examine the national debt as a percentage of GDP rather than as an absolute value?

Question 8

Who owns the U.S.debt? How much of the debt is owned by U.S.government agencies? How much is owned by individuals and how much is owned by foreigners?

Question 9

What is the difference between a nominal deficit and the real deficit? How can inflation wipe out the burden of the national debt? Who bears the cost of eliminating debt with inflation?

Question 10

Use the distinction between passive and structural deficits and surpluses to explain how the $5.9 trillion surplus that economists back in 2000 predicted would occur over 15 years quickly disappeared during the 2001/2002 recession.

Question 11

Define deficits,surpluses,and debt.How do accounting practices affect the definitions of deficits and surpluses?

Question 12

In which framework are government surpluses and deficits viewed as being better (or worse)for the economy-the short run or the long run? Explain.

Question 13

Why is it important to judge an economy's external debt relative to its assets? (Remember: an internal debt creates an equal amount of financial assets.)Give an example to support your explanation.

Question 14

How can inflation wipe out debt?

Question 15

How do accounting practices affect the definitions of deficits and surpluses? Explain.

Question 16

What's the difference between a structural and a passive budget deficit? What contributes to a passive deficit? Use the distinction between passive and structural deficits and surpluses to explain how the surplus in 2000 quickly disappeared during the 2001/2002 recession.

Question 17

What has been happening to the U.S.government debt and interest on that debt (relative to GDP)since WW II? What accounted for the budget surplus of the late 1990s and early 2000s?

Question 18

What has been happening to the U.S.government debt and the debt/GDP ratio since WW II?

Question 19

Is the effect of inflation on the debt a real one? Does it actually wipe out the real burden of the debt? Who (if anyone)bears the cost of eliminating debt with inflation?

Question 20

What is the difference between a nominal deficit and the real deficit? Write a formula that shows the relationship between the two.

Question 21

What is the debt service?

Question 22

The government has just issued a news bulletin announcing that it is currently running a budget deficit of $100 billion.Two economists are arguing (imagine!)over this announcement.One economist claims that the deficit is larger than the government is reporting,while the other maintains that the government is actually running a budget surplus.Here are the facts: the size of the economy is $7 trillion,potential output is $7.5 trillion,and the marginal tax rate is 25%.Government expenditures do not vary with income.It turns out that both economists are correct! How can this be? Hint: Consider the difference between the passive and the structural deficit concepts.

Question 23

Consider an economy with an annual GDP of $5 trillion that is growing at a real rate of 3% per year,and has a government debt of $3 trillion.
(a)What is this economy's relative debt burden?
(b)How much of a deficit can this economy's government have each year and still maintain its current relative debt burden?

Question 24

The nominal surplus is $100 billion,inflation is 3%,and total debt is $5 trillion.What is the real surplus?

Question 25

An economy's actual income is $800 billion,its potential income is $900 billion,and it has a budget deficit of $50 billion and a marginal tax rate of 25%.Government expenditures do not vary with income.What is its structural deficit? What is the passive deficit?

Question 26

The nominal deficit is $150 billion,inflation is 4%,and the total debt is $8 trillion.Does this economy have a real deficit or a real surplus? Show your calculations.

Question 27

An economy has a government debt of $6 trillion,its GDP is $10 trillion,and it has a 3% growth rate.
(a)What is its debt-to-GDP ratio?
(b)What size government budget deficit could this economy have without increasing the debt to GDP ratio?

Question 28

How does Social Security make the current budget deficit smaller than it otherwise would be?

Question 29

What has been happening to the U.S.interest/GDP ratio since WWII?

Question 30

(a)Explain the distinction between the nominal deficit and the real deficit.Explain why inflation wipes out debt.
(b)Demonstrate your understanding of this relationship by calculating the real deficit from the figures in the examples given below:
#1: Nominal deficit = $8 million; Inflation = 5%; Total debt = $100 million
#2: Nominal deficit = $8 million; Inflation = 8%; Total debt = $100 million
#3: Nominal deficit = $8 million; Inflation = 8%; Total debt = $200 million

Question 31

To earn money,you decide to open up a popcorn stand at your student union.At the end of your first year of operation,your financial condition is as follows: Assume that the opportunity cost of your time is zero.
(a)Did you run a deficit or a surplus during your first year?
(b)Assuming a four-year useful life for your popcorn-making machine,how does your answer to (a)change if you evenly depreciate the value of your machine?
(c)How do your answers to (a)and (b)relate to the government's budget balance calculations? Explain.