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Chapter 23
Federal Deficits and
the National Debt
• Key Concepts
• Summary
• Practice Quiz
• Internet Exercises
©2002 South-Western College Publishing
1
What is the purpose
of this chapter?
To take a closer look at the
actual budgetary process
that creates and finances
our national debt
2
What are the four stages
of the budget process?
• Agency budget proposals
• Presidential budget
submission
• First budget resolution
• Second budget resolution
3
What is the
federal fiscal year?
October 1 through
September 30
4
What is the
federal deficit?
How much money the
government borrows in
any given fiscal year
5
What is the
national debt?
The total amount owed by
the federal government to
owners of government
securities
6
How does the
U.S. Treasury
borrow money?
By selling Treasury bills,
notes, and bonds,
promising to make
specified interest payments
and to repay the loaned
funds on a given date
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Billions of dollars
$1,600
$1,400
$1,200
$1,000
$800
$600
$400
$200
Federal Expenditures
and Tax Revenues
Expenditures
Revenues
Year
65 70 75 80 85 90 95 00 05
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Percentage of GDP
24
23
22
21
20
19
18
17
Federal Expenditures, Revenues, and
Deficits as a Percentage of GDP
Federal
Deficit
Year
1985
1990
1995
2000
9
Surplus
Deficit
Billions of dollars
$+50
0
$-50
$-100
$-150
$-200
$-250
$-300
$-350
Federal Budget
Surpluses and Deficits
65 70
75 80 85 90 95 00 05
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What has been done to
curb the national debt?
• Tax increase
• Spending caps
• Line-item veto
• Debt ceiling
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What happened to
taxes in 1993?
• Raised the highest
marginal tax rate from
31% to 36%
• Increased tax on gasoline
by 4.3 cents per gallon
12
What happened to
spending in 1993?
Reduced military spending
and and cut some
entitlements, including
Medicare, Medicaid, and
food stamps
13
What is a debt ceiling?
The legislated legal limit
on the national debt
14
What usually happens
when the debt pushes
against the ceiling?
Congress raises the
ceiling to accommodate
the budget deficit
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The National Debt
$5
$4
$3
$2
Trillions of dollars
$6
National debt
$1
40
50
60
70
80
Year
90 00 05
16
Percentage of GDP
150
140
120
100
80
60
40
20
The National Debt as a
Percentage of GDP
40
National debt/GDP
Year
50
60
70
80
90
00 05
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What is the internal
national debt?
The portion of the
national debt owed to
a nation’s own
citizens
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What is the external
national debt?
The portion of the
national debt owed
to foreign citizens
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Percentage of GDP
4.0%
3.5%
3.0%
2.5%
2.0%
1.5%
1.0%
.05%
Federal Net Interest as
a Percentage of GDP
Year
50
60
70
80
90
00 05
20
Ownership of the National Debt
2000
Public Sector
Private Sector
Foreigners
21
What is the
crowding-out effect?
When federal government
borrowing increases
interest rates, the result is
lower consumption and
investments
22
Can the government
go bankrupt?
• Yes, it’s possible
• No, the debt need
never be paid off
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Are we passing the debt
burden to our children?
Yes, especially if it
continues to increase
No, not as long as the
debt is internally owned
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Does government
borrowing crowd out
private-sector
spending?
Yes, the more the government
borrows the less loanable
funds for everyone else
No, especially if it occurs
during economic downturns
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Complete (AD1), Partial (AD`2),
and Zero (AD2) Crowding Out
AS
200
150
E
100
50
1
full employment
2
4
E
E`2
2
AD1
6
AD2
AD`2
8
12
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Key Concepts
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Key Concepts
•
•
•
•
•
•
•
•
•
•
•
What is the federal deficit?
What is the national debt?
How does the U.S. Treasury borrow money?
What has been done to curb the national debt?
What is a debt ceiling?
What is the internal national debt?
What is the external national debt?
What is the crowding-out effect?
Can the government go bankrupt?
Are we passing the debt burden to our children?
Does government borrowing crowd out privatesector spending?
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Summary
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The national debt is the dollar
amount that the federal
government owes holders of
government securities. It is the
cumulative sum of past deficits.
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The U.S. Treasury issues
government securities to finance
the deficits. The debt has more
than tripled since 1980. The debt
ceiling is a method to restrict the
national debt.
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The National Debt
$5
$4
$3
$2
Trillions of dollars
$6
National debt
$1
40
50
60
70
80
Year
90 00 05
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Internal national debt is the
percentage of the national debt a
nation owes to its own citizens.
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External debt is a burden because
it is the portion of the national debt
a nation owes to foreigners.
34
Ownership of the National Debt
2000
Public Sector
Private Sector
Foreigners
35
The crowding-out effect is a
burden of the national debt that
occurs when the government
borrows to finance its deficit,
causing the interest rate to rise.
As the interest rate rises,
consumption and business
investment fall.
36
Can Uncle Sam go bankrupt?
The U.S. government will not go
bankrupt because it never has to
pay off its debt. When government
securities mature, the U.S.
Treasury can refinance or roll over
the debt by issuing new securities.
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Are we passing the debt burden
to our children? There are two
differing opinions on this
question.
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Are we passing the debt burden
to our children? No
One side of this argument is that
the debt is mostly internal, so
financing a deficit only involves
exchanging old bonds for new
bonds among U.S. citizens.
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Are we passing the debt burden to
our children? Yes
The sizeable external debt transfers
purchasing power to foreigners.
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Does government borrowing crowd
out private sector spending?
Keynesian theory assumes zero
crowding out when the federal
government increases spending in
order to shift the aggregate
demand curve rightward.
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Chapter 23 Quiz
©2002 South-Western College Publishing
42
1. During the late 1990’s, federal
government budget deficits
a. were completely removed.
b. dropped significantly from a high of
$300 billion.
c. remained fairly stable at about $150
billion per year.
d. exceeded $200 billion in each year.
B.
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Surplus
Deficit
Billions of dollars
$+50
0
$-50
$-100
$-150
$-200
$-250
$-300
$-350
Federal Budget
Surpluses and Deficits
65 70
75 80 85 90 95 00 05
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2. The federal government finances the
federal deficit by
a. taxing businesses and households.
b. selling Treasury securities.
c. printing more money.
d. reducing its purchases of goods and
services.
B. The U.S. Treasury borrows by selling
Treasury bill (T-bills), notes, and
bonds promising to make specified
interest and repay the loan on a given
date.
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3. In 1998, the national debt was
approximately
a. $60 billion.
b. $600 billion.
c. $6 trillion.
d. $5 trillion.
D.
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The National Debt
$5
$4
$3
$2
Trillions of dollars
$6
National debt
$1
40
50
60
70
80
Year
90 00 05
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4. The national debt
a. doubled between 1950 and 1980, and by
1990, it was over four times its size in
1980.
b. doubled between 1950 and 1980 and
doubled again between 1980 and 1990.
c. stayed at approximately the same
amount between 1950 and 1980 and
doubled between 1980 and 1990..
d. was four times larger in 1980 than it
was in 1950 and then doubled between
1975 and 1990.
A.
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The National Debt
$5
$4
$3
$2
Trillions of dollars
$6
National debt
$1
40
50
60
70
80
Year
90 00 05
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5. Which of the following countries has the
smallest national debt as a percentage of
GDP?
a. Italy.
b. Canada.
c. United Kingdom.
d. Japan.
e. France.
D.
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6. Which of the following is false?
a. The national debt’s size decreased
steadily after World War II until 1980
and then increased sharply each year.
b. The national debt increases in size
whenever the federal government has
a budget surplus.
c. The size of the national debt
currently is about the same size as it
was during World War II.
d. All of the above are false.
D.
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7. In 1998, how much of the U.S. national
debt was owed to foreigners?
a. About 2.5%.
b. About 17%.
c. About 31%.
d. About 59%.
B.
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8. Which of the following owns a
proportion of the national debt?
a. Federal, state, and local
governments.
b. Private U.S. citizens.
c. Banks.
d. Foreigners.
e. All of the above.
E. Treasury bills are widely held
throughout the public and private
sectors both domestically and
overseas.
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9. The portion of the U.S. national debt held
by foreigners
a. represents a burden because it
transfers purchasing power from U.S.
taxpayers to other countries.
b. is an accounting entry that represents
no real burden.
c. decreased as a proportion of the total
debt during the 1980’s.
d. has been constant for many decades.
A. Approximately 17 percent of total
U.S. debt is external debt.
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Ownership of the National Debt
2000
Public Sector
Private Sector
Foreigners
55
10. Which of the following statements
about crowding out is true?
a. It is caused by a budget surplus.
b. It is not caused by a budget surplus.
c. It cannot completely offset the
multiplier effect of deficit government
spending.
d. It affects interest rates and, in turn,
consumption and investment
spending.
D. The crowding-out effect is a reduction
in private spending caused by federal
deficits financed by U.S. Treasury
borrowing.
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11. Which of the following statements
about crowding out is true?
a. It can completely offset the multiplier.
b. It is caused by a budget deficit.
c. It is not caused by a budget surplus.
d. All of the above are true.
D. If crowding out occurs, reduced private
spending offsets the multiplier effect of
increased government spending. The debt is
a summation of each years deficits and
therefore effects consumption and
investments. No crowding out occurs with
budget surpluses because the government
is not competing with consumers and
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investors for available funds.
END
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