Budget Deficits and Government Debt

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Times Square in New York City is famous for counting
down to the New Year when the crystal New Year's
Eve ball drops to mark the moment the new year begins.
But nearby there's a clock of another sort, the National
Debt clock, which is counting up trillions of dollars as
the national debt increases.
In fact, nearly every government around the world is in debt,
and the total amount of money most governments owe is
typically around a year's income, which means that debt to
GDP ratios are often around one hundred percent.
These numbers are unimaginable. Do they mean anything?
They definitely mean something, but they may not mean what
most people think they mean.
So Betsy Justin. In our last episode, we talked about
fiscal policy and how government spending can help get an
economy out of a recession, and we've watched countries around
the world spend trillions of dollars in the wake of
the COVID crisis. But the end result of all that
spending is that governments in dozens of countries now have
even higher national debts.
Right government debt is growing in many countries and will
continue to grow because countries have made spending commitments that
exceed their revenue commitments.
Let me clear up some terms here. If the government
spends more than it's taking in as revenue than in
that year, it'll run a budget deficit, and each year's
budget deficit adds to the country's government debt.
A government's debt is the total amount of money the
government owes, and so today's government debt is the accumulation
of past budget deficits plus interest. We're going to explore
government debt and budget deficits in this week's episode of
Think Like an Economist with me Betsy Stevenson.
And I'm Justin. Wlfhas we're teaching you the tools from
economics that you can apply across your life, whether it's
managing your household debt or figuring out how much to
be worried about our government's debt. NaSTA antabocoli fire is
with us.
So the budget deficit is the flow of new borrowing
by the government in a year, while the total debt
is the stock of how much it owes right now.
So if you think about the government's finances as a bath,
and I know that's how you want to think about it,
then the budget deficit is the flow of new water
or new debt into that bath.
And therefore the debt is the level of water in
the tub.
In the fiscal bathtime.
Budget deficits also follow the business cycle, so if there's
a recession, the budget deficit will rise as the government
spends more money and takes in less tax revenue. It
has to borrow money to fund this difference between what
it's spending and what it's taking in.
On the other hand, countries can run budget surpluses when
they take in more revenue than they spend in that year.
While countries sometimes run budget surpluses for a year or two,
almost every country has government debt. The exceptions tend to
be countries that own a lot of resources like oil.
So most countries have some debt, but COVID led to
big annual budget deficits that lead to huge increases in debt.
Wars also create budget deficits as they require a large
and very sudden increasing government spending to fund the war
if it The US government's had some very large deficits
in the nineteen forties during the Second World War.
You can think of the government's mobilization against COVID as
being like a war, although it's a war against a
pathogen rather than a foreign country, and the mobilization to
defeat COVID and support the economy caused very large budget
deficits in many many countries.
When government spending can help spur growth in the future,
it can really make a lot of sense for governments
to borrow, particularly if interest rates are low.
It's similar to how people borrow money to go to
school or buy a house. It makes sense to pay
for those things over time, and with student debt, most
people still end up with more income even after paying
that debt than if they hadn't gone.
To school at all, So all this concern about deficits
from politicians. Is this a political argument or an economic one?
Well, it's a little bit of both. So let's think
about the politics of it. Nobody wants the other guys
spending priorities to get through, So if you don't like
the spending, the best argument is, hey, it's going to
raise budget deficits. It's going to raise a debt. I
don't want to do it.
And part of its economic which is a higher budget deficit,
means the government is borrowing, which can help crowd out
private businesses from being able to borrow.
There's obviously a limit to how much can be done,
and that's the sense in which it's a fight over
what do we want to spend on and how much
debt do we want to accumulate.
And we hear the term balanced budget a lot, as
in governments to try to get their spending and revenue
to line up amy for.
A balanced budget every year. It's just a bad idea
because it can prolong recessions, make them deeper, make us
worse off.
Think about it. A recession comes along and so people's
thing comes full, which means that tax revenues will fall
and also more people will need benefits, so government spending
will rise, so it looks like it's facing a budget deficit.
But if it has to balance its budget, all of
a sudden, the government's going to cut spending or raise taxes.
One of the things I've been hearing about a lot
lately is that government debt is rising pretty sharply in
a bunch of countries. Is there a useful way to
quantify how much the government Those.
Economists off a measure government debt relative to the size
of a country's economy, which provides really useful perspective. This
is the idea of a debt to GDP ratio, which
compares how much a government has borrowed relative to its
capacity to create the income it'll need to make payments.
So, in the United States, the debt to GDP ratio
in twenty twenty one was around one hundred percent. What
does this mean.
It means that the US has borrowed an amount equal
to one hundred percent of a single year's worth of
its total production or income. Might sound worrying that its
debt exceeds its income, but realize it only exceeds this
year's income. We also have lots of income in future
years to help pay this off.
Infect In Japan, government debt is more than two hundred
percent of GDP in so far, at least, that hasn't
caused it serious problems.
People sometimes wonder if there's some magic number which government
debt creates problems, but so far economists haven't found any
clear tipping point that can lead a country to ruin.
Sometimes the problem isn't the level of government debt today,
but rather it's trajectory and whether the government will be
able to make adjustments before it gets into trouble.
In the US, we expect debt to rise over the
next few decades as our population ages. This is because
the government's made a lot of promises to people about
how much they're going to get in retirement and what
kind of healthcare coverage they're going to get paid for
by the government. People really don't want to see taxes rise,
but it's going to be hard to fund all of
these people in their retirement.
The COVID rescue plans have also been really large, and
the government borrowed even more money to fund them.
The more you borrow, the larger interest rate bill is
going to be. And if you're not at least paying
the interest on your debts, and your debt will continue
to grow just because of rising interest costs.
And should people be worried about rising government debt in
the future.
I'll give you an economist answer, which is, on the
one hand, yes. On the other hand, note, so let's
talk about some of the key ideas that ought to
inform your answer.
There is a saying in economics that government budget is
not like a family and it's true. They're really different.
So if you use analogies to your family budget, you'll
often come to faulty conclusions.
For instance, well, you have to pay off all your debts.
The government debts don't have to be paid off just
by the current group of citizens. The government can pay
off its debt really slowly, over many decades and over
many generations.
But I've seen some really scary statistics though. For example,
in the US, the government owed about twenty one trillion
dollars in twenty twenty, which in a country of three
hundred and thirty million, Well, that breaks down to about
sixty thousand dollars per person.
Yeah, no, it sounds like a lot, but realistic government
actually will probably spend about a million dollars on you
over the course of your lifetime. So sixty thousand dollars
in the context of that million just means the government's
cutting back a little bit on what it would spend
on you.
Future generations can help too, if we share the burden
with a future three hundred and thirty million people. Well,
right there, I've just had each person's share of the
national debt, you know, and the.
Government doesn't really need to pay its debts off fully
to be sustainable. We need to think about debt as
being sustainable if it's stable relative to the size of
the economy. So you don't need to pay off that
sixty thousand per person. You just need to make enough
payments that it doesn't rise faster than our ability to pay.
And so this is the idea that we want the
debt to GDP ratio to be stable.
Yes, so if the US debt is equal to one
hundred percent of this year's GDP, and if that ratio
stays stable, so that next year is equal to one
hundred percent of next year's GDP, and the year after
it's still equal to one hundred percent of that year's
GDP and so on, then this seems pretty sustainable. This
would be a pattern that would seem to say this
is a government that can keep up with its payments.
This also suggests some different economic strategies. If you want
to keep your debt to GDP ratio from rising, one
way is to make sufficient payments on your debt. Another
way is for the economy to grow faster.
Betty's right, and she's talking about one of the key
reasons why economists aren't overly concerned with government debt at
the moment. They compare two numbers. The first is the
real interest rate, which is the rate that the debt
would grow at if we'd make no repayments.
The second is the economic growth rate, which is the
rate at which our ability to repay the debt is rising.
If the real interest rate is low with an economic
growth rate, and the government stops running deficits, then our
debt will naturally continue to rise more slowly in GDP.
And hence the debt to GDP ratio will fill. Economists
love to talk in code, so sometimes they'll say that
debt isn't a problem with R less than G. By
R they mean the real interest rate, and G means
the economic growth rate.
The idea is that if we have a lot of
economic growth, then our ability to repay the debt will
grow faster than we're accumulating debt.
That's why it makes sense to ask what the government
is spending on and why it's spending. Is it spending
on an investment like in people or infrastructure or research
into new ideas. If so, this kind of spending is
more likely to be easy to pay back because it's
going to contribute to economic growth.
And other ways. Where government budgets are different from family budgets.
You bet the government has options that you don't if
you fall into debt, as it can impact your ability
to get credit in the future, and it can be
tough to quickly raise enough cash to get out of
that debt. It's easier for government to raise revenue. It
can just raise taxes, and even raising taxes by just
a few percentage points can be enough to raise billions
of dollars of revenue and help stabilize the debt to
GDP ratio, The.
Government has one more option that people don't, and that's
that it can just print money to repay their debts. However,
while this seems like a solution, it can be really
costly because it can lead to inflation and also even
cases of hyper inflation. The classic example is hyper inflation
in the Weimar Republic in the nineteen twenties, and Venezuela's
current crisis is a more recent example of a government
printing money to pay its debt and causing hyperinflation.
Inflation's a tricky way for government to officially repay its debt,
but do so in a way way that it can
afford and the people it borrows from hate. After inflation,
the government can often repay the full amount of the
debt it owes, say in dollars, but it can repay
only because it's paying in dollars that are worth a
lot less.
I definitely do not recommend the strategy of inflating away
the debt. Lenders understand when governments do this to them,
and it makes them reluctant to lend to those governments
again in the future, or it lends to them at
really high interest rates.
There's another reason to well. I don't want to say
not worry, but perhaps worry somewhat less about government debt,
and that's because it's money we owe ourselves. What I
mean by this is that most of the money the
US government has borrowed has actually been linked to it
by Americans, and so it's money that one group of Americans,
that is the government, owes to another group of Americans.
You've given us some reasons not to be so concerned
about debt, but you still said that you were somewhat concerned. Now,
why is that?
An important problem is that government borrowing can push up
interest rates. Basically, the government's borrowing money that might otherwise
be used to fund new businesses starting up, or existing
businesses investing in new machinery or research and development. In
this case, higher debt can come at the expense of
somewhat slower economic growth.
High government debt also makes it harder for governments to
borrow if they suddenly need funds, say if there's a
national emergency like a natural disaster, a pandemic, or another recession.
Another problem is that higher debt may lead lenders to
worry that they might not get paid back, so they
might demand higher interest rates. Now here's the problem. Higher
interest rates may actually make it harder for governments to
pay it back because it's going to increase the overall
interest payments The government has to pay each year, which
makes the debt problem even worse.
It's even worse than that, it can create what we
call a crisis of confidence. The problem is that the
perception the government debt is unsustainably high can lead lenders
to charge really high interest rates, and those really high
interest rates now mean the government really can't make it
its repayments.
This sort of self fulfilling prophecy was a huge problem
for Greece during the global financial crisis. As it became
clear that Greece's debt was higher than they understood, investors
became concerned that Greece wouldn't be able to repay its debts.
That fear pushed the interest rate from five percent up
to twenty five percent.
At that rate, it was really impossible for Greece to
meet its annual interest payments. Ultimately, the European Union and
the International Monetary Fund had to step in with emergency
loans in a recovery program, and years later, the Greek
economy is still trying to get back on its feet.
The final reason to be concerned about government debt is
high debt can lead to a debt crisis. Government doesn't
just borrow money on a thirty year fixed term that
they have to repay in the future. Rather, it's constantly
got debts coming due, some of which it pays by
getting new loans, which is called rolling over the debt.
But if Linda's decided they don't want to lend to
your government, then you've got a crisis.
You've got loans to repay, but no way of borrowing
to do it.
Your only choice is to abruptly raise taxes and cut spending.
This is what happened during the Latin American debt crisis
in nineteen eighties, and the sharp cut and government spending
quickly caused a recession.
So there's a lot to consider here. I'm still trying
to figure out where I stand on rising government debt.
A lot of us are really used to thinking about
our own personal spending and budgeting and debts, but how
can we start to think about the government's debt.
Thinking about your own debt is probably the wrong starting point.
That comes with all sorts of anxieties built in, and
it's really not a good analogy. Now, as an individual,
you usually can't have your grandchildren pay off your debts,
whereas future generations can help make payments on the national debt.
In fact, federal government never needs to pay off its debt.
The thing is governments are infinitely lived, and that means
that debt can be infinitely lived.
Also, you can't inflate away your personal debt. A government
can inflate away its debt, even though we've said it's
not a good idea. And in addition, the government can
just raise taxes. It doesn't have to go and get
a second job if it wants to start to make
payments on its loans.
You know, politicians often draw analogies between the national debt
and household budgets, even though we've explained why that's flawed.
Former British Prime Minister Margaret Thatcher is famous for having
said that the government should do what any good housewife
would do if money were tight, look at their accounts
and see what's wrong.
The reality, though, is that often when politicians say they're
concerned about debt, they're more concerned about spending. They might
want less spending, but they'll point to the debt because
they think that's a more persuasive argument.
That's why where you far on this debate as to
whether we should worry about government debt Really depends on
your values.
A lot of countries that are racking up debt right now,
they're racking up that debt making investments that are also
going to benefit future generations.
These bigger debts could also hinder future generations if the
government can't borrow because of unsustainable debt.
So all of this is about the relationship between today's
generations and future generations.
You know, if you look around today, you can see
the kinds of benefits we have because of the investments
that previous generations made, But we also have some debt
to pay because of the spending that previous generations did.
So it's a difficult trade off and a hard values question.
What balance of debt and infrastructure, you know, things like
roads and technology do you think we should leave for
the next generation.
When I talk to young people today, you know, they
have some concerns about the debt, but they also have
a lot of concerns about climate change and about research
into new ideas into development. And I think these are
real questions about where your values are. Should we be
spending more to a dress climate change, to address new
ideas to improve technology, or should we be worried about
the debt.
Let's see justin Thanks, these are some really important topics
for us all to grapple with and to figure out,
because they're going to be affecting us for the years
to come.
And they're not just going to be affecting you and
I and as they're going to be affecting my kids
as well, because they're going to inherit either the wonderful
infrastructure or the terrible debts that we decide to incur.
But I do think it's important for people to realize
that reasonable people can disagree here. It's up to you
to decide whether the government spending is worth the debt
that's being accumulated, and whether it makes sense for future
generations that they'll benefit from the spending or whether they're
going to be burdened by the debt. Thanks for listening.
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