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Macroeconomics ECO 403
VU
LESSON 35
GOVERNMENT DEBT
Government debt and the annual budget deficit
·  When a government spends more than it collects in taxes, it borrows from the private
sector to finance the budget deficit.
·  The government debt is an accumulation of all past annual deficits.
Components of Domestic Debt
·
Permanent Debt
­  Market Loans
­  Federal Government Bonds
­  Income tax Bonds
­  National Funds Bonds
­  Federal investment Bonds
­  Prize Bonds
·
Floating Debt
­  Treasury Bills
­  Market Treasury Bills
·
Unfunded Debts
­  Savings or Deposit Certificates
­  Savings Account
­  Postal Life insurance
­  GP Fund
Domestic Debt Outstanding
million rupees
STOCK
Flow up to
30-Jun-04
31-Jan-05
31-Jan-05
A:Permanent Debt
536,800
512,956
(23,844)
B:Floating Debt
542,943
611,648
68,704
C:Unfunded Debt
899,215
890,474
(8,741)
Total (A + B + C)
1,978,958
2,015,078
36,120
163
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Macroeconomics ECO 403
VU
Trends in Public Debt
Rs. Billions
End June
1990
1995
2000
2001
2002
2003
2004
Debt payable in Rs
373.6
789.7
1575.9
1728.0
1715.2
1853.7
1921.4
% of GDP 42.8
42.3
41.5
41.5
39.1
38.4
35.2
Debt payable in
427.6
872.5
1670.4
2025.8
1984.1
1891.3
1927.1
Forex
% of GDP 48.9
46.8
44.0
48.6
45.1
39.2
35.3
Total Public Debt
801.2
1662.2
3246.4
3753.8
3699.3
3745.0
3848.5
Grants
33.4
40.5
83.1
114.2
42.6
Net Public Debt
801.2
1662.2
3213.0
3713.3
3616.2
3630.8
3805.9
% of GDP 91.7
89.1
84.7
89.2
82.2
75.3
69.7
Source: Debt office, Ministry of Finance
Budget Deficit of Pakistan
(as percentage of GDP)
10
9
8
7
6
5
4
3
2
1
0
Problems in Measurement
Govt. Budget Deficit = Govt. Spending ­ Govt. Revenue
= Amount of new debt
·
A meaningful deficit...
­  Modifies the real value of outstanding public debt to reflect current inflation.
­  Subtracts govt. assets from govt. debt.
­  Includes hidden liabilities that currently escape detection in the accounting system.
­  Calculates a cyclically-adjusted budget deficit
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Macroeconomics ECO 403
VU
Inflation
·
Almost all economists agree that the government's indebtness should be measured in real
terms, not in nominal terms. The measured deficit should equal the change in the
government's real debt, not the change in its nominal debt
·
However, the commonly measured budget deficit does not correct for inflation
·
An example
­ Suppose the real government debt is not changing. In other words, in real terms, the
budget is balanced
­ In this case, the nominal debt must be rising at the rate of inflation. i.e.
ΔD / D = š
Where š is the inflation rate and D is the stock of government debt
­ This implies
ΔD = š D
·
So by looking at the change in nominal debt ΔD, a budget deficit of šD can be reported
·
Hence most economists believe that the reported budget deficit is overstated by the amount
šD
·
Another perspective
Govt. budget deficit = govt. Expenditure ­ Govt. Revenues
­  For correct measurement of budget deficit, the government expenditure should include
only the real interest paid on the debt (rD), not the nominal interest paid (iD)
­  Since
i­r=š
Budget deficit is overstated by šD
·
Example:
In 1979
Budget deficit = $28 billions
š = 8.6 %
Government debt = $495 billion
Budget Deficit overstated, šD = 0.086 x 495
= $43 billion
So,
$28 - $43= $ 15 billion surplus
Capital Assets
·
An accurate assessment of government's budget deficit requires accounting for the govt.'s
assets as well as liabilities
·
Particularly, when measuring govt.'s overall indebtness, we should subtract government
assets from government debt. So
Govt. budget deficit = change in debt ­ change in assets
·
Individuals and firms treat assets and liabilities symmetrically
·
Borrowing to buy a house does not amount to budget deficit, because the increase in
assets (house) is offset by increase in debt (lease rent) and thus, no change in net wealth
165
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Macroeconomics ECO 403
VU
·
A budget procedure that accounts for assets as well liabilities is called capital budgeting,
because it takes into account the changes in capital.
·
For Example
­  The government sells some of its land or buildings and uses the proceeds to reduce the
budget deficit
· Under current budget procedure, the reported deficit would be lower
· Under capital budgeting, reduction in debt would be offset by a reduction in assets
­  Similarly, government borrowings to finance purchase of capital assets would not raise
budget deficit
·
Problem with capital Budgeting
­ It is hard to decide which government expenditures should count as capital
expenditures.
Uncounted Liabilities
·
Measuring budget deficit may be misleading because it excludes some govt. liabilities.
­ Pension of Govt. workers
­ Social security system
·
Although social security liabilities can be differentiated from government debt, yet the
government can always choose not to repay all of its debt.
The Business Cycle
·
Changes occur automatically in response to a fluctuating economy.
·
Example: Recession
­  Incomes  Personal Taxes
­  Profits  Corporate Taxes
­  Number of needy persons  G
Budget Deficit Increases
·
These automatic changes are not errors in measurement since government truly borrows in
such situations.
·
But this makes it difficult to use deficit to monitor changes in fiscal policy. i.e the deficit can
either fall or rise either because
­  Government has changed its policy or
­  Economy has changed direction
·
Cyclically adjusted (full employment) budget deficit reflects policy changes but not the
current stage of the business cycle
166
Table of Contents:
  1. INTRODUCTION:COURSE DESCRIPTION, TEN PRINCIPLES OF ECONOMICS
  2. PRINCIPLE OF MACROECONOMICS:People Face Tradeoffs
  3. IMPORTANCE OF MACROECONOMICS:Interest rates and rental payments
  4. THE DATA OF MACROECONOMICS:Rules for computing GDP
  5. THE DATA OF MACROECONOMICS (Continued…):Components of Expenditures
  6. THE DATA OF MACROECONOMICS (Continued…):How to construct the CPI
  7. NATIONAL INCOME: WHERE IT COMES FROM AND WHERE IT GOES
  8. NATIONAL INCOME: WHERE IT COMES FROM AND WHERE IT GOES (Continued…)
  9. NATIONAL INCOME: WHERE IT COMES FROM AND WHERE IT GOES (Continued…)
  10. NATIONAL INCOME: WHERE IT COMES FROM AND WHERE IT GOES (Continued…)
  11. MONEY AND INFLATION:The Quantity Equation, Inflation and interest rates
  12. MONEY AND INFLATION (Continued…):Money demand and the nominal interest rate
  13. MONEY AND INFLATION (Continued…):Costs of expected inflation:
  14. MONEY AND INFLATION (Continued…):The Classical Dichotomy
  15. OPEN ECONOMY:Three experiments, The nominal exchange rate
  16. OPEN ECONOMY (Continued…):The Determinants of the Nominal Exchange Rate
  17. OPEN ECONOMY (Continued…):A first model of the natural rate
  18. ISSUES IN UNEMPLOYMENT:Public Policy and Job Search
  19. ECONOMIC GROWTH:THE SOLOW MODEL, Saving and investment
  20. ECONOMIC GROWTH (Continued…):The Steady State
  21. ECONOMIC GROWTH (Continued…):The Golden Rule Capital Stock
  22. ECONOMIC GROWTH (Continued…):The Golden Rule, Policies to promote growth
  23. ECONOMIC GROWTH (Continued…):Possible problems with industrial policy
  24. AGGREGATE DEMAND AND AGGREGATE SUPPLY:When prices are sticky
  25. AGGREGATE DEMAND AND AGGREGATE SUPPLY (Continued…):
  26. AGGREGATE DEMAND AND AGGREGATE SUPPLY (Continued…):
  27. AGGREGATE DEMAND AND AGGREGATE SUPPLY (Continued…)
  28. AGGREGATE DEMAND AND AGGREGATE SUPPLY (Continued…)
  29. AGGREGATE DEMAND AND AGGREGATE SUPPLY (Continued…)
  30. AGGREGATE DEMAND IN THE OPEN ECONOMY:Lessons about fiscal policy
  31. AGGREGATE DEMAND IN THE OPEN ECONOMY(Continued…):Fixed exchange rates
  32. AGGREGATE DEMAND IN THE OPEN ECONOMY (Continued…):Why income might not rise
  33. AGGREGATE SUPPLY:The sticky-price model
  34. AGGREGATE SUPPLY (Continued…):Deriving the Phillips Curve from SRAS
  35. GOVERNMENT DEBT:Permanent Debt, Floating Debt, Unfunded Debts
  36. GOVERNMENT DEBT (Continued…):Starting with too little capital,
  37. CONSUMPTION:Secular Stagnation and Simon Kuznets
  38. CONSUMPTION (Continued…):Consumer Preferences, Constraints on Borrowings
  39. CONSUMPTION (Continued…):The Life-cycle Consumption Function
  40. INVESTMENT:The Rental Price of Capital, The Cost of Capital
  41. INVESTMENT (Continued…):The Determinants of Investment
  42. INVESTMENT (Continued…):Financing Constraints, Residential Investment
  43. INVESTMENT (Continued…):Inventories and the Real Interest Rate
  44. MONEY:Money Supply, Fractional Reserve Banking,
  45. MONEY (Continued…):Three Instruments of Money Supply, Money Demand