Growing National Debt

Should we be worried?

Federal Deficit Federal DebtLeads to a larger

$16.7 Trillion

Joe & Bob“It’s not only what you owe”

Deficit & Debt relative to GDP

• Current Deficit = 1.3 Trillion (2012 numbers)

• Current Debt = 16.7 Trillion• Current GDP = 15.8 Trillion

• Deficit as % of GDP = 8.0% of GDP– Highest since World War II– Recent high (1983) 6% of GDP

• Debt as % of GDP =105.0% of GDP– Highest ever (1946) was 120% of GDP

NATIONAL DEBT AS % OF GDP

Debt:16.7 Trillion

GDP15.8 Trillion

105 % GDP

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Interest Rates

• Interest rates are the price of borrowing money– There are short term & long term interest rates– The Federal Reserve only controls short term interest rates

• Government Bonds represent long term interest rates– the interest rate Government borrows money at!

• Low interest rates are critical for a healthy economy – As interest rates ↑ => cost of borrowing money ↑ => GDP falls

Crowding Out Handout

Gov’t Deficit Spending

Leads to Rising Federal DebtLeads to Rising Federal Debt

Gov’t must sell more bondsGov’t must sell more bonds

Forces long term Interest Rates Higher

(crowds out private investor—they borrow less money for investments because interestrates are higher)

Forces long term Interest Rates Higher

(crowds out private investor—they borrow less money for investments because interestrates are higher)

Economic Theory of: “Crowding Out”

More Gov’t Deficit Spending

Leads to Rising Federal Debt

Gov’t must sell more bonds (borrow more $)

Forces long term Interest Rates Higher

(crowds out private investor—they borrow less money for investments because interest rates are higher)

GDP falls => could lead to recession

Has the Rising Debt hurt the U.S. ?

Has Crowding Out Occurred?

10-Year Gov’t Bond Interest Rate

No! U.S. interest ratesare historically low!

Short Run analysis:

Structural deficit: occurs with the economy at full potential output (peak of business cycle, high GDP)

Cyclical deficit: Portion of deficit attributable to a slowdown in the business cycle (during recession)

2-Types of Deficits

Structural Deficits are significantly more problematic than

Cyclical DeficitsThey do not go away when the economy improves

Analyzing Deficits Summary

• Debt & Deficit should be viewed as % GDP

– This allows you to compare past deficits

• Deficits can place upward pressure on long term interest rates

– This is known as crowding out

• Today’s Deficit is primarily a structural deficit

– Entitlement spending must be addressed to correct it

Changing EntitlementsSocial Security, Medicare & Medicaid

Social Security Medicare

Balancing the Budget?“The only real question” is whether adjustments to taxes and spending will come from a “careful and deliberative process” or from a “rapid and painful response to a looming or actual fiscal crisis,” Ben Bernanke Chairmen of Federal Reserve

2010

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Debt as a % of GDP

Reading: Greece & Austerity?

U.S. Debt in Comparison

• Greece 125% of GDP

• Italy 115% of GDP

• European Union (EU) debt limit of 60%

• Japan 180% of GDP– Japanese citizens save money => so they buy Japanese Gov’t Bonds– No crowding out!

Growth of Entitlements

*Current services estimate.

Source: Budget of the United States Government, FY 2005, Office of Management and Budget.

Defense Social Security

Net interest

Medicare & Medicaid

All other spending

1964 1984 2004*

9% 19%

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