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Public Debt

C h a p t e r 1 4. Public Debt. The History of U.S. and U.K. Public Debt. The nominal quantity of interest-bearing debt and the ratio of this debt to nominal GDP. The History of U.S. and U.K. Public Debt. The History of U.S. and U.K. Public Debt. The Data of Chinese Public Debt.

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Public Debt

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

  2. The History of U.S. and U.K. Public Debt • The nominal quantity of interest-bearing debt and the ratio of this debt to nominal GDP Macroeconomics Chapter 14

  3. Macroeconomics Chapter 14

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

  5. The History of U.S. and U.K. Public Debt Macroeconomics Chapter 14

  6. The Data of Chinese Public Debt • From 1981 (中国市场统计年鉴2001年7-27) 1990 890.34 1991 1059.99 1992 1282.72 1993 1540.74 1994 2286.40 1995 3300.30 1996 4361.43 1997 5508.93 1998 7765.70 1999 10542.00 2000 13674.00 • 2008年6月末中央财政国债总余额为52385.86亿元，控制在年末55185.85亿元国债余额限额以内 (2008年上半年国债管理报告) • 财政部部长助理张通9日表示，2009年财政政策较大幅度增加中央财政赤字，并相应增加国债发行规模，中央财政国债余额限额为62708.35亿元。 (2009年04月09日 16:02　来源：中国新闻网 ) Macroeconomics Chapter 14

  7. Characteristics of Government Bonds • We assume that government bonds pay interest and principal in the same way as private bonds. • We assume that bondholders (households in our model) regard government bonds as equivalent to private bonds. Macroeconomics Chapter 14

  8. Characteristics of Government Bonds • total bond holdings= Bt+ Bgt • total bond holdings= private bonds+ government bonds • Bt= 0 still holds in the aggregate. • total bond holdings of all households= Bgt Macroeconomics Chapter 14

  9. Budget Constraints and Budget Deficits • The Government’s Budget Constraint • Gt+ Vt= Tt+ ( Mt− Mt−1)/ Pt • The real value of these interest payments, it−1·(Bgt−1/Pt) adds to the government’s expenditure or uses of funds on the left-hand side of the government’s budget constraint. Macroeconomics Chapter 14

  10. Budget Constraints and Budget Deficits • The Government’s Budget Constraint • Gt + Vt+ it−1·(Bg t−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 Chapter 14

  11. Budget Constraints and Budget Deficits • Assuming Mt, Pt, do not change over time: • Gt+ Vt+ rt−1·Bgt−1/P = Tt+ (Bgt− Bg t−1)/P Macroeconomics Chapter 14

  12. Budget Constraints and Budget Deficits • The Budget Deficit • real government saving = − (Bgt− Bgt−1)/P Macroeconomics Chapter 14

  13. Budget Constraints and Budget Deficits • The Budget Deficit • − (Bgt− Bgt−1)/P = Tt− 【Gt+ Vt+ rt−1·Bgt−1/P】 • real government saving = real taxes− real government expenditure Macroeconomics Chapter 14

  14. Budget Constraints and Budget Deficits • The Budget Deficit • the government’s revenue exceeds its expenditure, and the government has a budget surplus. • the government has a balanced budget, and the government’s real saving is zero. Macroeconomics Chapter 14

  15. Budget Constraints and Budget Deficits Macroeconomics Chapter 14

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

  17. Budget Constraints and Budget Deficits Household’s multiyear budget constraint • C1 + C2/(1+r1) + ··· = (1+r0)·( B0/P+K0) +(w/P)1·Ls1 +(w/P)2·Ls2 /(1+r1)+ ··· +( V1 − T1) + ( V2 − T2)/( 1 + r1) +( V3 − T3)/[(1+ r1) ·( 1 + r2) ] + ··· Macroeconomics Chapter 14

  18. Budget Constraints and Budget Deficits • multiyear household budget constraint with government bonds • C1 + C2/(1+r1) + ··· = (1+r0)·( B0/P+Bg0/P+K0) +(w/P)1·Ls1 +(w/P)2·Ls2 /(1+r1) + ··· +( V1 − T1) + ( V2 − T2)/( 1 + r1) +( V3 − T3)/[(1+ r1) ·( 1 + r2) ] + ··· Macroeconomics Chapter 14

  19. Budget Constraints and Budget Deficits • A Simple Case of Ricardian Equivalence • r0 = r1 = r2 = ··· = r . • Mt, and Pt, do not change over time. • Real transfers, Vt, are zero each year. • the government has a given time path of purchases, Gt Macroeconomics Chapter 14

  20. Budget Constraints and Budget Deficits • A Simple Case of Ricardian Equivalence • Government Budget Constraint • Gt+ r·Bgt−1/P = Tt+ (Bgt−Bgt−1)/P • the government starts with Bg0/P = 0. • In year 1：G1 = T1 + Bg1/P Macroeconomics Chapter 14

  21. Budget Constraints and Budget Deficits • A Simple Case of Ricardian Equivalence • Suppose, to begin, that the government balances its budget each year. • Then in year1 G1 = T1 • Continuing on, if the government balances its budget every year, • Bgt /P, =0 in every year t. Macroeconomics Chapter 14

  22. Budget Constraints and Budget Deficits • A Simple Case of Ricardian Equivalence • now the government runs a real budget deficit of one unit? • the deficit must come from a cut in real taxes, T1, by one unit. • the real deficit of one unit requires the government to issue one unit of real public debt at the end of year 1 • Bg1/P = 1. Macroeconomics Chapter 14

  23. Budget Constraints and Budget Deficits • A Simple Case of Ricardian Equivalence • Assume Bg2/P = Bg3/P = ··· = 0. • G2 + r·Bg1 /P = T2 + (Bg2−Bg1)/P • Bg1/P = 1 and Bg2/P = 0 • G2 + r = T2 − 1 • T2 = G2 + 1 + r Macroeconomics Chapter 14

  24. Budget Constraints and Budget Deficits • A Simple Case of Ricardian Equivalence • decrease in year 1’s real taxes+ present value of increase in year 2’s taxes = −1 + (1 + r)/(1 + r) = −1 + 1 = 0 Macroeconomics Chapter 14

  25. Budget Constraints and Budget Deficits • A Simple Case of Ricardian Equivalence • If the government replaces a unit of real taxes with a unit of real budget deficit, households know that the present value of next year’s real taxes will rise by one unit. Thus, the real budget deficit is the same as a real tax in terms of the overall present value of real taxes. This finding is the simplest version of the Ricardian equivalence theorem on the public debt. Macroeconomics Chapter 14

  26. Budget Constraints and Budget Deficits • Ricardian Equivalence • HH views real taxes as equivalent to a real budget deficit. • In terms of national saving HH saving offsets government’s dissaving Macroeconomics Chapter 14

  27. Budget Constraints and Budget Deficits • Another Case of Ricardian Equivalence • G2 + r·Bg1 /P = T2 + (Bg2−Bg1)/P • Bg2/P = Bg1/P = 1 • G2 + r = T2 Macroeconomics Chapter 14

  28. Budget Constraints and Budget Deficits • Ricardian Equivalence More Generally • C1 + C2/(1+r1) + ··· = (1+r0)·( B0/P+Bg0/P+K0) +(w/P)1·Ls1 +(w/P)2·Ls2 /(1+r1) + ··· +( V1 − T1) + ( V2 − T2)/( 1 + r1) +( V3 − T3)/[(1+ r1) ·( 1 + r2) ] + ··· Macroeconomics Chapter 14

  29. Budget Constraints and Budget Deficits • Ricardian Equivalence More Generally • t=1: T1 decreases 1 • t=2: T2 increases r • t=3: T3 increases r • ··· • we find again that the deficit-financed tax cut in year 1 has no income effects on households. Macroeconomics Chapter 14

  30. Budget Constraints and Budget Deficits • Ricardian Equivalence More Generally • If the time path of Gt is given (and if Vt = 0), we can show that a higher Bg0/P requires the government to collect a correspondingly higher present value of real taxes, Tt, to finance the debt. • This higher present value of real taxes exactly offsets the higher Bg0/P. Thus, we still have no income effects on households. Macroeconomics Chapter 14

  31. 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 stimulative fiscal policy. Macroeconomics Chapter 14

  32. Economic Effects of a Budget Deficit • Lump-Sum Taxes • the cut in year 1’s real taxes, T1, and the increases in future real taxes, Tt, all involve lump-sum taxes. • no substitution effects on consumption and labor supply. • We have found in our equilibrium business-cycle model that a deficit-financed tax cut does not stimulate the economy. In particular, real GDP, Y, gross investment, I, and the real interest rate, r , do not change Macroeconomics Chapter 14

  33. Economic Effects of a Budget Deficit • Labor Income Taxes • The fall in T1 is accompanied by a decline in (τw)1. • The changes in marginal income tax rates, (τw)1 and (τw)2, affect the labor market in years 1 and 2. Macroeconomics Chapter 14

  34. Economic Effects of a Budget Deficit Macroeconomics Chapter 14

  35. Economic Effects of a Budget Deficit Macroeconomics Chapter 14

  36. 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 Chapter 14

  37. Economic Effects of a Budget Deficit • Labor Income Taxes • a budget deficit allows the government to change 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 Chapter 14

  38. 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 induce changes in the timing of various aspects of economic activity: L, Y, C, and I. Macroeconomics Chapter 14

  39. Economic Effects of a Budget Deficit • 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. Macroeconomics Chapter 14

  40. Economic Effects of a Budget Deficit • 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 Chapter 14

  41. Economic Effects of a Budget Deficit • Strategic Budget Deficits • This view of the Reagan-Bush budget deficits after 1983 gave rise to a new theory called strategic budget deficits. • The word “strategic” is used because the models involve political strategies analogous to those analyzed in game theory. Macroeconomics Chapter 14

  42. Economic Effects of a Budget Deficit • Ricardian equivalence - a deficit-finance tax cut does not affect real GDP and other macroeconomic variables. • The Standard View of a Budget Deficit • a deficit-financed tax cut makes households feel wealthier, consumption, C1, increases。 Macroeconomics Chapter 14

  43. Economic Effects of a Budget Deficit • The Standard View of a Budget Deficit • 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 Chapter 14

  44. 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 Chapter 14

  45. Economic Effects of a Budget Deficit • The Standard View of a Budget Deficit • Key assumption: A deficit-financed tax cut makes households feel wealthier. • Two arguments: • Finite lifetimes • Imperfect credit markets Macroeconomics Chapter 14

  46. Economic Effects of a Budget Deficit • Finite lifetimes • The decrease in the present value of real taxes for current generations coincides with an increase in the present value of real taxes for members of future generations. Individuals will be born with a liability for a portion of taxes to pay the interest and principal on the higher stock of real public debt. • These people will not share in the benefits from the earlier tax cut. Present taxpayers would not feel wealthier if they counted fully the present value of the prospective taxes on descendants. Macroeconomics Chapter 14

  47. Economic Effects of a Budget Deficit • Finite lifetimes • However, most people have private intergenerational transfers • Public debt changes the optimal private transfers – offset the effect of public debt • Uncertainty of future taxes? – precautionary saving Macroeconomics Chapter 14

  48. Economic Effects of a Budget Deficit • Imperfect credit markets • When credit markets are imperfect, some households will calculate present values of future real taxes by using a real interest rate above the government’s rate. • Thus, public debt is not a burden Macroeconomics Chapter 14

  49. Economic Effects of a Budget Deficit • Empirical evidence • Budget deficit and national saving Causality? Correlation? • US and Canada. • Israel in 1983-87 Macroeconomics Chapter 14

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

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