ECOS2002 Intermediate Macroeconomics
Week 13:
Christopher Gibbs
University of Sydney
Semester 1, 2021
Government Debt and Budget Deficits
Government Debt
Government Debt and Budget Deficits
The difference between debts and deficits
Deficits = Tax Revenue Government Spending
Deficits are a flow.
Debts = The total amount of money owed by a government
to any party.
Debts are a stock.
Government Debt and Budget Deficits Measurement
Measurement of Government Debt
When do we know a government has too much debt?
Should we think about government debt the same way we
think about personal debt?
Measurement of Government Debt
The general answer to these questions is
There appears to be no correct answer for this question.
You have too much debt when people stop lending.
No, government debt cannot be thought about like personal
debt with the exception of a few cases.
Measurement of Government Debt
Government debt cannot be thought about like personal
debt because of
Governments theoretically never die.
Inflation.
Legal issues surrounding capital assets.
Measurement of Government Debt
Governments do not die
Governments can always roll over debt.
This means a government can theoretically always take out
a new loan to pay an old loan.
Therefore, governments must only pay interest and never
principle.
Measurement of Government Debt
The role of inflation:
We should care about real debt and not nominal debt.
Inflation erodes the real value of the principle the
government owes.
Therefore, it is possible for the government to balance the
budget in real terms, while still growing the nominal stock
of debt:
Dnew Dold
Dold
= ?
where D is stock of nominal government debt.
Measurement of Government Debt
The role of inflation:
However
, inflation does affect the interest rate on the debt.
Therefore, higher inflation rates will decrease the real value
of the principle, but will increase the interest rate paid to
issue new debts.
Measurement of Government Debt
The role of inflation:
A country that issues debt in their own currency can never
default on that debt.
A debt issued in Australian Dollars is a promise by the
government to pay in Australian Dollars and they can also
turn on the printing press to make the payment.
A government that does not issue debt in a currency it fully
controls is at risk of experiencing a self-fulling debt crisis
Measurement of Government Debt
Capital Assets
Individuals and corporations measure their debts against
their assets.
Theoretically governments could do the same thing.
The Australian government has many assets: roads,
insurance companies (Medibank), land.
The debt can compared to these assets and not just GDP
as the government can sell assets to pay the debt i.e. as
they are about to do with Medibank.
They could also sell land
like Tasmania to New Zealand
Measurement of Government Debt
Capital Assets
Therefore, debt to GDP may not be the only measure to
consider.
However, political and legal restrictions make it hard for the
government to liquidate assets.
Government Budgets
A simple model of government budgets and finance
The Treasurys Budget Constraint
Gt + it-1BtT-1 = Tt + (BtT BtT-1) + RCBt (1)
The Federal Reserve Constraint
(BtM BtM-1) + RCBt = it-1BtM-1 + (Mt Mt-1) (2)
Debt held by the public
B = BT BM (3)
Where G is government spending, B is bonds, M is the
monetary base (think M1), and RCB is receipts from the
Central Bank.
Government Budgets
Combining the two yields the Federal Governments Budget
Constraint.