Debt & Deficits
W&L Econ 102
US$11 trillion in national debt
State / local debt modest in macro terms
Remember, they’re not allowed to run big deficits!
History shows current debt level doesn’t
represent a short-run “crisis”
Huge structural deficits [blue]
even corrected for cyclical (recession-driven) component
Even when adjusted to real (share of GDP) level
And lots of debt held by non-residents
Because private savings low
Remember (S-I) + (T-G) = (X-M) and with low S and low T...
And while historically monetary policy eventually shifts savings a bit....
No help this time
around! Remember C
has fallen < === >
savings rate has risen
Sum of Effects
• Deficits exceed savings (net of investment)
– Hence tend to drive up i
• And lower I and increase the trade deficit (X-M)
• In other words, (modest) crowding out = lower LR growth
• Deficits financed by non-residents
– We owe some of our taxes to the Chinese & Saudis
– But we owe in US dollars
• So no Mexico-style foreign exchange crisis is possible
• But in the future we will have to tighten our belts (cut some
combination of C, I, G) to export more and import less
• We can’t – and (fortunately!) we don’t have to!
– We simply roll over our [$11 trillion and growing...] debt
• When $10 bil comes due, we mail out $10 bil in checks
– And institutional investors buy $10 bil in newly issued debt
– But interest costs matter
• If debt-to-GDP ratio is high, interest costs can explode
– But much debt is long-term so stable if high i temporary
• We cannot allow debt-to-GDP to rise forever
• Stability requires covering the cost of debt i
• Net of growth
• At a zero deficit, D’ = D (1 + i) debt growth
• Y’ = Y (1 + g) economic growth
– So need budget surplus of D/Y * (i – g) to stabilize
• If i = 4%, g = 2% and 100% debt to GDP
– We need a surplus of 2% of GDP
• And 200% requires 4% of GDP, still manageable
• Of course at present we have a deficit, so the swing in
tax rates must be larger
Long run issues
• Baby boomers will (are starting to!) retire
– Those born in 1948 qualify for Medicare in 2013
– Social security is roughly balanced
• We might need to raise taxes by 2% of GDP, easy to manage
– Medicare is NOT stable
• We need to raise taxes by 4% (under the optimistic scenario)
– And by more with (a) greater longevity and (b) higher healthcare
expenses, both looking likely ... and don’t you want (a)
• From a LR budgetary perspective healthcare is
the top priority, by a large measure
• All retirement is Pay-Go
– We cannot save as a society for retirement
• Fallacy of composition between individual and macro
– Small countries have wiggle room: they can accumulate foreign
assets to finance eventual trade deficits. But not the U.S.
– The services and goods you consume at age 65 in
retirement in 2054 have to be produced in 2052
• For you to consume those working can’t
– In past history children only briefly cared for parents
• Life cycle transfers were (a) within the family (b) from old to
• Now they’ll be (a) outside the family (b) from young to old
• So will saving be voluntarily or compulsory?
• Voluntary = private savings to buy assets of retirees
• Involuntary = govt financed transfers
– Social security, medicare
» Public education and child care are conceptually similar!
– Voluntarism isn’t reliable
• People cashing their 401-K’s this year face poverty
• No guarantee the young will buy when you need to sell
– But since the young don’t vote, and the increasingly numerous
elderly do, won’t politics push us towards tax-funded
Don’t rue this!
• Our society is fortunate
• that people live long enough to retire!
– Plus we are beginning this process
– With really low tax rates, unlike the EU
• But in a steep recession so we can’t start yet
– And high debt-to-GDP levels will raise the cost, modestly
• How can your generation avoid this?
– Have lots and lots of children!!
• You’d have to fund childcare
– But your parents will still want to retire, so it really doesn’t help you
– So don’t retire until age 70 ... and then retire to Mexico?
• How will the politics of this social compact evolve?
• A good senior thesis topic!