An old song urges us to “look for the silver lining” in any cloud. Our nation’s return to large budget deficits under the Bush administration makes things easier for teachers like me. As I teach macroeconomics this fall, I know that all of the recent news about the 2003 budget deficit will focus my students’ attention when we cover the role of fiscal policy in an economy.
National debts and deficits are widely misunderstood. Many people in the general public really don’t distinguish between the two. Moreover, many people have only a hazy idea of to whom the debt is owed, when and if it must be paid, and how a national debt does or doesn’t affect the daily life of the average citizen.
The debt/deficit distinction is a good place to start. A budget deficit is specific to one year. If the federal government runs a $455 billion deficit in 2003, it simply means that the government will spend $455 billion more than it will take in this year. We make up this difference, the budget deficit, by borrowing. Borrowing adds to the national debt.
The national debt is the sum of all budget deficits and surpluses from the time the United States was established. Every year that we run a budget deficit, we add to the debt. When we run a budget surplus, we reduce the debt.
A country like the United States does not take out a loan from banks. It borrows by “selling” bonds. A bond is simply an IOU or promissory note establishing a legal obligation to repay a specified amount of money at some time in the future along with some specified amount of interest.
The federal government is not alone in borrowing by issuing bonds. Corporations, cities, school districts and other entities frequently borrow in this manner. Technically, the “bonds” that constitute our national debt have a number of different names. We can speak of Treasury bills, notes and bonds as well as “savings bonds.” These distinctions are not important to the average citizen; they all refer to variations of the same basic government IOU.
So who lends money to the government by “buying” government bonds? It may be U.S. individuals, insurance companies, pension plans, mutual funds or banks. It may be people or entities from a foreign country.
Government bonds are a safe investment, and anyone who has money to invest may consider them along with stocks, certificates of deposit or real estate. The risk that the bond will not be paid off when it matures is near zero. Moreover, bonds are very liquid. If circumstances change and a bond owner wants cash instead of her bond, there is always a willing buyer, even if the bond will not mature for years.
The picture is complicated considerably by the fact that one branch of government can lend to another.
The Federal Reserve lends money to the Treasury when the Fed buys bonds to increase the money supply. It does so in open bond markets, along with all the other buyers listed above, and so such monetary policy actions are called “open-market operations.”
The Social Security Administration also lends to the Treasury. When FICA taxes for Social Security exceed benefits paid out in any given year, the surplus is invested in special Treasury bonds. We are running such surpluses, and the amounts of these Social Security trust funds are increasing. As more baby boomers retire, the annual FICA surpluses will turn to deficits and Social Security will begin to cash in the Treasury bonds it holds.
At one time, the proportion of the national debt owed to the Fed and to Social Security was quite small. A half-century ago, it was about 18 percent but now approaches half of the “gross federal debt.” At the end of 2002, the gross national debt was about $6.2 trillion dollars. Of that, $2.7 trillion was owed to the Federal Reserve, to Social Security and to a few other miscellaneous government “trust funds.” Only $3.5 trillion was owed “to the public.”
These sums sound enormous, but one has to keep in mind that our nation produced goods and services worth about $10.5 trillion in 2002. This gross domestic product is roughly analogous to a household’s income. I would be very happy if my total indebtedness was only 60 percent of what I earn in one year. I would be even happier if nearly half of my debt was an obligation from me to my wife. The existing level of national debt is not, in itself, any problem to worry about.
Students often express concern about “how will we pay off the national debt.” The simple answer is that we probably never will. Like many households, we roll our debt forward in time, refinancing as we need to. Some of the government bonds that make up the debt come due every month. We pay them off from surplus revenues or by simply selling new bonds. Unlike households, nations do not have a specified life expectancy. A nation does not have an “estate” that has to be liquidated at death.
We have had some level of national indebtedness for over 200 years. Historically, both the absolute amount of debt and its size relative to the economy declined during periods of peace and prosperity and rose in wartime. There was some deficit spending in peacetime, particularly after the Eisenhower administration, but dramatic increases in debt are largely a feature of the administrations of Ronald Reagan and Bush father and son.
© 2003 Edward Lotterman
Chanarambie Consulting, Inc.