Government Budget Constraint
Government budget constraint: G=T+ΔD+ΔM
- Where:
- G: government spending
- T: tax revenue
- ΔD: change in government debt (bonds) held by the public
- ΔM: change in money supply
Government Budget Constraint
Government budget constraint: G=T+ΔD+ΔM
Government budget surplus: G<T
Government budget deficit: G>T
Government Budget Constraint
- Government budget deficit: G>T
Government must pay for excess spending by either:
Debt finance (+ΔD): selling government bonds to the public (borrowing money)
Inflationary finance (+ΔM): "printing" money for the government to spend (and causing inflation)
Adam Smith on Governments' "Juggling Trick"
Adam Smith
1723-1790
"When it becomes necessary for a state to declare itself bankrupt, in the same manner as when it becomes necessary for an individual to do so, a fair, open, and avowed bankruptcy is always the measure which is both least dishonourable to the debtor and least hurtful to the creditor. The honour of a state is surely very poorly provided for when, in order to cover the disgrace of a real bankruptcy, it has recourse to a juggling trick of this kind [borrowing money or its debasing currency], so easily seen through, and at the same time so extremely pernicious," (Book V, Chapter 3)"
Smith, Adam, 1776, An Enquiry into the Nature and Causes of the Wealth of Nations
Government Deficits vs. Debt
Government deficits are a flow variable: amount added per year
Government debt is a stock variable: total amount measured at a point in time
Deficit flows that are financed by government borrowing are added to the debt stock
- Debt is the accumulated deficit
Government Spending and Revenues
Government Spending and Revenues (as % of GDP)
Government Budget Surplus or Deficit
Government Budget Surplus or Deficit
Government Budget Surplus or Deficit
Government Budget Surplus or Deficit (as % of GDP)
Total Public Debt
Total Public Debt as % of GDP
U.S. Debt Clock
Debt as % of GDP Around the World
Mandatory vs. Discretionary Spending
Federal gov't spending can be broken into:
Mandatory spending: federal programs that are automatic based on a defined benefit to an eligible person, doesn't require yearly appropriation by Congress
- Often called entitlement spending and "off-budget spending"
- Social Security, Medicare, Medicaid
Discretionary spending: Congress specifically appropriates an amount of funding from the budget each year to each government agency
- Defense and everything else
2019 Federal Budget
Mandatory Spending
Mandatory Spending
Mandatory Spending: Social Security
Issuing New Government Debt
- U.S. Department of the Treasury sells various government bonds (I.O.U.s) to
- private investors (domestic & foreign)
- other government agencies
- Federal Reserve (in exchange for new currency - monetary policy)
Issuing New Government Debt
- Treasury bill ("Treasurys"): maturity of ≤1 year
- Zero-coupon bond: pays no interest, but sold at discount on face value
- Treasury note ("T-notes"): maturity of 2-10 years
- Coupon payments every 6 months
- Treasury bond ("T-bonds"): maturity of 20-30 years
- Same as T-note, longer maturity
Who Are the Bondholders?
Issuing New Government Debt
U.S. government debt is considered "risk-free" because (it is widely believed that) the U.S. will never default on its payments to bondholders
U.S. government (unlike private companies!) can always raise taxes to pay its bondholders
Municipalities in Default
Debt Ceiling
U.S. Loses Its Stellar Credit Rating (2011)
U.S. Current Credit Ratings
(S&P) Credit Ratings on Government Debt Around the World
Ricardian Equivalence
Ricardian equivalence: hypothesis that consumers/taxpayers are future-oriented and internalize the government's budget constraint
Government spending increases today (or equivalently, tax cuts) imply that:
Government will, in the future, have to pay for the spending increase with either:
- higher taxes
- more debt
- more inflation
Each of these methods impose burdens on consumers
Political Incentives
Politicians like to increase government spending (their constitutents like new programs and benefits)
To pay for them, consider the political incentives of:
- raising taxes
- issuing new bonds
- "printing" more money
Rationally ignorant taxpayers and consumers hardly notice government debt or inflation, but will notice higher taxes
Democracy in Deficit
L: James M. Buchanan (1919-2013)
R: Richard E. Wagner (1941-)
"A nation cannot survive with political institutions that do not face up squarely to the essential fact of scarcity: It is simply impossible to promise more to one person without reducing that which is promised to others. And it is not possible to increase consumption today, at least without an increase in saving, without having less consumption tomorrow. Scarcity is indeed a fact of life, and political institutions that do not confront this fact threaten the existence of a prosperous and free society."
Democracy in Deficit
L: James M. Buchanan (1919-2013)
R: Richard E. Wagner (1941-)
"What happened? Why does Camelot lie in ruin? Viet Nam and Watergate cannot explain everything forever. Intellectual error of monumental proportion has been made, and not exclusively by the ordinary politicians. Error also lies squarely with the economists. The academic scribbler of the past who must bear substantial responsibility is Lord Keynes himself, whose ideas were uncritically accepted by American establishment economists. The mounting historical evidence of the effects of these ideas cannot continue to be ignored. Keynesian economics has turned the politicians loose; it has destroyed the effective constraint on politicians' ordinary appetites. Armed with the Keynesian message, politicians can spend and spend without the apparent necessity to tax."
Buchanan, James M and Richard E Wagner, 1977, Democracy in Deficit: The Political Legacy of Lord Keynes
Political Incentives
Political Incentives
Math Isn't a Partisan Issue
"The nation cannot continue to sustain the spending programs and policies of the past with the tax revenues it has been accustomed to paying. Citizens will either have to pay more for their government, accept less in government services and benefits, or both." (Congressional Budget Office, 2011)
What Economists Think
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It's Not Getting Any Better...
