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C h a p t e r 1 4 Public Debt

C h a p t e r 1 4 Public Debt. The History of U.S. and U.K. Public Debt. The History of U.S. and U.K. Public Debt. The History of U.S. and U.K. Public Debt. Characteristics of Government Bonds. Government bonds pay interest and principal.

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C h a p t e r 1 4 Public Debt

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  1. C h a p t e r 1 4 Public Debt Macroeconomics - Barro Chapter 14

  2. The History of U.S. and U.K. Public Debt Macroeconomics - Barro Chapter 14

  3. The History of U.S. and U.K. Public Debt Macroeconomics - Barro Chapter 14

  4. The History of U.S. and U.K. Public Debt Macroeconomics - Barro Chapter 14

  5. Characteristics of Government Bonds • Government bonds pay interest and principal. • Bondholders (households in our model) save by buying those government bonds just as equivalent to private bonds. Macroeconomics - Barro Chapter 14

  6. Budget Constraints and Budget Deficits • Expanded Government’s Budget Constraint • Gt + Vt+ it−1·(Bgt−1/ Pt) = Tt+ (Bgt− Bg t−1)/Pt+ (Mt−Mt−1)/Pt • real purchases+ real transfers+ real interest payments = real taxes + real debt issue + real revenue from money creation Macroeconomics - Barro Chapter 14

  7. Budget Constraints and Budget Deficits • A Budget Surplus − (Bgt− Bgt−1)/P = Tt− (Gt+ Vt+ rt−1·Bgt−1/P) • real government saving = real taxes− real government expenditure Macroeconomics - Barro Chapter 14

  8. Budget Constraints and Budget Deficits • Budget Surplus: the government’s revenue exceeds its expenditure. • Budget Deficit: the government’s expenditure exceeds its revenue. • Balanced Budget: the government’s real saving is zero. Macroeconomics - Barro Chapter 14

  9. Budget Constraints and Budget Deficits Macroeconomics - Barro Chapter 14

  10. Budget Constraints and Budget Deficits • Public Saving, Private Saving, and National Saving • real household saving( economy-wide) = Kt− Kt−1 + (Bgt− Bgt−1)/ P Macroeconomics - Barro Chapter 14

  11. Budget Constraints and Budget Deficits • Public Saving, Private Saving, and National Saving • when we combine government and household saving, the change in real government bonds, (Bgt− Bgt−1)/P, cancels out. An increase in real government bonds means that the government is saving less and that households are saving correspondingly more. • real national saving= Kt− Kt−1 Macroeconomics - Barro Chapter 14

  12. Economic Effects of a Budget Deficit • What happens in the equilibrium business-cycle model when the government cuts year 1’s real taxes, T1, and runs a budget deficit? Economists often refer to this type of change as a simulative fiscal policy. Macroeconomics - Barro Chapter 14

  13. Economic Effects of a Budget Deficit • Labor Income Taxes • Instead of lump-sum taxes, the government levies taxes on labor income. Consider again a reduction in year 1’s real taxes, T1, financed by a budget deficit. We assume that the fall in T1 is accompanied by a decline in the marginal income tax rate, (τw)1. Macroeconomics - Barro Chapter 14

  14. Economic Effects of a Budget Deficit • Labor Income Taxes • The changes in marginal income tax rates, (τw)1 and (τw)2, affect the labor market in years 1 and 2. Macroeconomics - Barro Chapter 14

  15. Economic Effects of a Budget Deficit Macroeconomics - Barro Chapter 14

  16. Economic Effects of a Budget Deficit • Labor Income Taxes • The increase in (τw)2 lowers labor supply in year 2. This decrease in labor supply leads, when the labor market clears, to a lower quantity of labor, (L2). The reduced labor input leads to a decrease in year 2’s real GDP, Y2. Macroeconomics - Barro Chapter 14

  17. Economic Effects of a Budget Deficit • Labor Income Taxes • a budget deficit allows the government to change the timing of labor-income tax rates and thereby alter the timing of labor input and production. • A budget deficit that finances a cut in year 1’s tax rate on labor income motivates a rearrangement of the time pattern of work and production—toward the present (year 1) and away from the future (year 2). Macroeconomics - Barro Chapter 14

  18. Economic Effects of a Budget Deficit Macroeconomics - Barro Chapter 14

  19. Economic Effects of a Budget Deficit • Asset Income Taxes • changes in the timing of asset-income tax rates cause changes in the timing of consumption, C, and investment, I. The general point is that, by running budget deficits or surpluses, the government can change the timing of various tax rates. The government can induce changes in the timing of various aspects of economic activity: L, Y, C, and I. Macroeconomics - Barro Chapter 14

  20. The Timing of Taxes and Tax-Rate Smoothing • We have found that budget deficits and surpluses allow the government to change the timing of tax rates. However, it would not be a good idea for the government randomly to make tax rates high in some years and low in others. • The public debt has typically been managed to maintain a pattern of reasonably stable tax rates over time. This behavior is called tax-rate smoothing. Macroeconomics - Barro Chapter 14

  21. Economic Effects of a Budget Deficit • The Standard View of a Budget Deficit • a deficit-financed tax cut makes households feel wealthier, consumption, C1, increases. • year 1’s inputs of labor and capital services stay the same, and real GDP, Y1 does not change. • Since C1 increases, gross investment, I1, has to decline for given government purchases, G1. Macroeconomics - Barro Chapter 14

  22. Economic Effects of a Budget Deficit • The Standard View of a Budget Deficit • These long-term negative effects on capital stock and real GDP are sometimes described as a burden of the public debt Macroeconomics - Barro Chapter 14

  23. Social Security • Retirement benefits paid through social security programs are substantial in the United States and most other developed countries. • Feldstein argue that these public pension programs reduce saving and investment. Macroeconomics - Barro Chapter 14

  24. Social Security • Social security is not a fully funded system where workers’ payments accumulate in a trust fund, which later provides for retirement benefits. • Pay-as-you-go system, in which benefits to elderly persons are financed by taxes on the currently young. Macroeconomics - Barro Chapter 14

  25. Economic effects of social security in a pay-as-you-go system. • When a social security system starts or expands, elderly persons experience an increase in the present value of their social security benefits net of taxes (positive income effect on this group). Macroeconomics - Barro Chapter 14

  26. Economic effects of social security in a pay-as-you-go system. • Young persons face higher taxes, offset by the prospect of higher retirement benefits. • the fall in consumption by the currently young tends to be smaller than the increase for the currently old. • Increase in current aggregate consumption. • Total private saving declines. • Increase in the interest rate. • Reduction in investment. • Reduced capital stock in the long run. Macroeconomics - Barro Chapter 14

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