GOVERNMENT DEBT:Permanent Debt, Floating Debt, Unfunded Debts

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Macroeconomics ECO 403

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

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

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Macroeconomics ECO 403

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

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)

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

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

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Macroeconomics ECO 403

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

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