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Chapter 28: Problem 12

Your study partner argues that the distinction between the government's budget deficit and debt is similar to the distinction between consumer savings and wealth. He also argues that if you have large budget deficits, you must have a large debt. In what ways is your study partner correct and in what ways is he incorrect?

Short Answer

Expert verified
#tag_title# Short answer The comparison made by the study partner between the government's budget deficit and debt and the distinction between consumer savings and wealth is partially accurate. The distinction between budget deficit and debt is similar to the distinction between consumer savings and wealth, as both refer to flow measures (budget deficits and savings) and stock measures (government debt and wealth). However, it is incorrect to claim that large budget deficits must result in large government debt, as other factors such as economic growth, inflation, and interest rates can also impact debt levels.

Step by step solution

01

Define government's budget deficit and debt

The government's budget deficit occurs when its expenses or spending exceeds its revenues or income. A budget deficit can lead to the government borrowing money to cover the shortfall. Government debt, on the other hand, is the total amount of money the government owes to creditors, including both domestic and foreign entities. It is the accumulation of budget deficits and surpluses over time, where a surplus is the opposite of a deficit. #Step 2: Define consumer savings and wealth#
02

Define consumer savings and wealth

Consumer savings refers to the portion of income that is not spent on consumption (goods and services) and is instead set aside for future use or investment. Savings can be held in various forms, such as bank accounts, securities, and investments. Wealth, on the other hand, is the total value of assets owned by an individual or household, including property, investments, and cash, minus any debts owed. #Step 3: Compare the distinctions#
03

Compare the distinctions

By comparing the definitions of budget deficit to consumer savings and government debt to consumer wealth, we observe that the distinction between budget deficit and debt is somewhat similar to the distinction between consumer savings and wealth. Both budget deficits and savings refer to a flow measure, which reflects current government or individual financial situation. In contrast, government debt and wealth describe the stock measures, which represent the aggregate financial position or accumulated result of previous flows. #Step 4: Analyze the relationship between budget deficits and government debt#
04

Analyze the relationship between budget deficits and government debt

Large budget deficits over a period of time can indeed lead to an increase in government debt, as the government borrows to cover its expenses. However, it is important to note that other factors can influence the level of government debt, such as a country's economic growth, inflation rate, and interest rates on the borrowed money. Additionally, a large debt is not necessarily the result of large budget deficits alone; it could also be due to a low or negative economic growth, high interest payments, or currency devaluation. #Step 5: Evaluate the study partner's argument correctness and incorrectness#
05

Evaluate the study partner's argument correctness and incorrectness

The study partner is correct in stating that the distinction between government's budget deficit and debt is similar to the distinction between consumer savings and wealth, as both distinctions refer to the flow measures and the stock measures. However, it is not entirely correct to state that having large budget deficits must result in a large debt. Although large deficits can contribute to an increase in government debt, other factors such as economic growth, inflation, and interest rates can also impact the debt levels.

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Most popular questions from this chapter

In 2014 , the policy makers of the economy of Eastlandia projected the debt- GDP ratio and the ratio of the budget deficit to GDP for the economy for the next 10 years under different scenarios for growth in the government's deficit. Real GDP is currently \(\$ 1,000\) billion per year and is expected to grow by \(3 \%\) per year, the public debt is \(\$ 300\) billion at the beginning of the year, and the deficit is \(\$ 30\) billion in 2014 . a. Complete the accompanying table to show the debt-GDP ratio and the ratio of the budget deficit to GDP for the economy if the government's budget deficit remains constant at \(\$ 30\) billion over the next 10 years. (Remember that the government's debt will grow by the previous year's deficit.) b. Redo the table to show the debt-GDP ratio and the ratio of the budget deficit to GDP for the economy if the government's budget deficit grows by $3 \%$ per year over the next 10 years. c. Redo the table again to show the debt-GDP ratio and the ratio of the budget deficit to GDP for the economy if the government's budget deficit grows by $20 \%$ per year over the next 10 years. d. What happens to the debt-GDP ratio and the ratio of the budget deficit to GDP for the economy over time under the three different scenarios?

Unlike households, governments are often able to sustain large debts. For example, in \(2013,\) the U.S. government's total debt reached \(\$ 17.3\) trillion, approximately equal to \(101.6 \%\) of GDP. At the time, according to the U.S. Treasury, the average interest rate paid by the government on its debt was \(2.0 \%\). However, running budget deficits becomes hard when very large debts are outstanding. a. Calculate the dollar cost of the annual interest on the government's total debt assuming the interest rate and debt figures cited above. b. If the government operates on a balanced budget before interest payments are taken into account, at what rate must GDP grow in order for the debt-GDP ratio to remain unchanged? c. Calculate the total increase in national debt if the government incurs a deficit of \(\$ 600\) billion in 2014 . d. At what rate would GDP have to grow in order for the debt-GDP ratio to remain unchanged when the deficit in 2014 is \(\$ 600\) billion? e. Why is the debt-GDP ratio the preferred measure of a country's debt rather than the dollar value of the debt? Why is it important for a government to keep this number under control?

How did or would the following affect the current public debt and implicit liabilities of the U.S. government? a. In 2003 , Congress passed and President Bush signed the Medicare Modernization Act, which provides seniors and individuals with disabilities with a prescription drug benefit. Some of the benefits under this law took effect immediately, but others will not begin until sometime in the future. b. The age at which retired persons can receive full Social Security benefits is raised to age 70 for future retirees. c. Social Security benefits for future retirees are limited to those with low incomes. d. Because the cost of health care is increasing faster than the overall inflation rate, annual increases in Social Security benefits are increased by the annual increase in health care costs rather than the overall inflation rate.

Show why a \(\$ 10\) billion reduction in government purchases of goods and services will have a larger effect on real GDP than a \(\$ 10\) billion reduction in government transfers by completing the accompanying table for an economy with a marginal propensity to consume \((M P C)\) of \(0.6 .\) The first and second rows of the table are filled in for you: on the left side of the table, in the first row, the \(\$ 10\) billion reduction in government purchases decreasesa. When government purchases decrease by \(\$ 10\) billion, what is the sum of the changes in real GDP after the 10 rounds? b. When the government reduces transfers by \(\$ 10\) billion, what is the sum of the changes in real GDP after the 10 rounds? c. Using the formula for the multiplier for changes in government purchases and for changes in transfers, calculate the total change in real GDP due to the \(\$ 10\) billion decrease in government purchases and the \(\$ 10\) billion reduction in transfers. What explains the difference? (Hint: The multiplier for government purchases of goods and services is \(1 /(1-M P C)\). But since each \(\$ 1\) change in government transfers only leads to an initial change in real GDP of \(M P C \times \$ 1\), the multiplier for government transfers is $M P C /(1-M P C) .)$

In which of the following cases does the size of the government's debt and the size of the budget deficit indicate potential problems for the economy? a. The government's debt is relatively low, but the government is running a large budget deficit as it builds a high-speed rail system to connect the major cities of the nation. b. The government's debt is relatively high due to a recently ended deficit- financed war, but the government is now running only a small budget deficit. c. The government's debt is relatively low, but the government is running a budget deficit to finance the interest payments on the debt.
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