Hi - Can you please help me come up with a simple, easy-to-understand response to a fellow classmate's response in a discussion board using a citation from the attached chapter. ?He mentions passing the debt to our future generations but I need to counter that comment with your assistance.? Simple and easy to understand response please...
10 Viviane Moos/Corbis Budget Deficits and the National Debt Learning Outcomes
By the end of this chapter, you will be able to:
? Distinguish between a deficit and a debt and explain their relationship with fiscal policy.
? Explain how the national debt has grown and what efforts have gone into reducing the deficit.
? Describe the difference between the actual deficit, the structural deficit, and the cyclical deficit.
? Understand the pros and cons of running deficits and having a large national debt.
? Explain why it may be difficult to reduce the national debt. __ama80496_10_c10_279-302.indd 279 12/4/12 4:46 PM Pre-Test CHAPTER 10 Introduction T he economy took such a hit during the 2007?2009 recession that Senators Kent
Conrad and Judd Gregg (D-North Dakota and R-New Hampshire, respectively)
proposed a bipartisan budget commission in the Bipartisan Task Force for Responsible Fiscal Action Act of 2009 (?Senators Conrad and Gregg,? 2009). This bill would have
established a task force to assure the long-term fiscal stability and economic security of
the federal government of the United States. There was also talk that if the bill did not
pass, then the commission would be created by presidential order instead. President
Obama put his stamp of approval on the formation of this panel in January of 2010.
?These deficits did not happen overnight and they won?t be solved overnight,? he said.
?The only way to solve our long-term fiscal challenge is to solve it together?Democrats
and Republicans? (Calmes, 2010). Would such a bipartisan budget commission accomplish the goal of slashing the deficit? Would cutting the federal deficit precipitate another
economic downturn or recession? This chapter attempts to address these questions. Pre-Test
1. The national debt is the amount owed to the states by the federal government. a. True b. False
2. In the 1980s, the debt and deficits both grew at a rate greater than growth of
output. a. True b. False
3. The structural deficit is the same as the cyclical deficit. a. True b. False
4. The real deficit is the deficit divided by the GDP. a. True b. False
5. Interest rates are likely to be lower when the deficit is reduced. a. True b. False
1. b. False. The answer can be found in Section 10.1.
2. a. True. The answer can be found in Section 10.2.
3. b. False. The answer can be found in Section 10.3.
4. b. False. The answer can be found in Section 10.4.
5. a. True. The answer can be found in Section 10.5. __ama80496_10_c10_279-302.indd 280 12/4/12 4:46 PM Section 10.1? Debt and Deficits CHAPTER 10 10.1? Debt and Deficits C itizens, the media, and even politicians often get confused by the difference between
the national debt, which is a stock concept, and a budget deficit, which is a flow
concept. A deficit is the amount by which the federal government?s expenditures
exceed its revenues in a given year (the fiscal year, which runs from October 1 to September 30). The national debt is the cumulative total of all past budget deficits minus all past
surpluses. It is the amount owed to lenders by the federal government.
Deficits are nothing new. The United States began its history with a national debt. The
Revolutionary War was financed by printing money?before there was a government
with taxing power. One of the major problems facing the first Congress in 1789 was the
retirement of $79 million in national debt, about two thirds of it from the Revolutionary
War. By the second term of President Andrew Jackson in the 1830s, the entire debt had
been repaid (Wright, 2008).
The U.S. government ran budget surpluses for much of the 19th century. However, both
the Union and the Confederacy ran large deficits to finance the Civil War. Except for periods during the Civil War and World War I, federal budget deficits were quite small before
the 1930s. In 1929, just before the Great Depression, the national debt stood at $16.9 billion, or about 16% of gross domestic product (GDP). Comparing the size of the debt to the
size of the economy by using the percentage of GDP is more meaningful than just looking at the absolute value of the debt because the capacity to repay the debt grows as the
Three years into the Great Depression (1932), the federal budget had become unbalanced
by a sharp drop in output, employment, and the price level. Both Herbert Hoover and
Franklin Roosevelt ran for president in that year on a campaign promise to balance the
budget. By 1939, at the outbreak of World War II, the national debt had nearly tripled to
$48.2 billion, or 55% of GDP. World War II brought a large increase in output but an even
larger increase in government borrowing. At the end of the war, the national debt stood at
$260.1 billion, or 122% of GDP. The debt was reduced slightly in the next few years. Then
it began to grow very slowly, much more slowly than GDP. Deficit Growth, 1970?2010
In the 1970s, the debt grew rapidly along with nominal GDP, so the ratio of debt to GDP
was relatively stable. By 1980, the national debt held by the public stood at $908.5 billion,
but had fallen to 34% of GDP. The 1980s saw a rapid rise in both the national debt and
GDP. Between 1980 and 1993, the size of the national debt tripled, from less than $1 trillion
to more than $4 trillion, or 72% of GDP. The estimated 2010 debt held by the public was
$9.3 trillion, or 64% of GDP?the highest ratio since just after World War II.
Table 10.1 shows the budget deficit since 1977. Figure 10.1 plots the national debt relative
to GDP to illustrate the progression of the ratio over time. __ama80496_10_c10_279-302.indd 281 12/4/12 4:46 PM CHAPTER 10 Section 10.1? Debt and Deficits Table 10.1: National debt relative to GDP (in billions of dollars)
Year Federal Deficit National Debt Debt/GDP Net 1977 53.7 706.4 35.7% 1978 59.2 776.6 35.0% 1979 40.7 829.5 33.1% 1980 73.8 909.0 33.3% 1981 79.0 994.8 32.5% 1982 128.0 1,137.3 35.2% 1983 207.8 1,371.7 39.8% 1984 185.4 1,564.6 40.6% 1985 212.3 1,817.4 43.8% 1986 221.2 2,120.5 48.1% 1987 149.7 2,346.0 50.4% 1988 155.2 2,601.1 51.9% 1989 152.6 2,867.8 53.1% 1990 221.0 3,206.3 55.9% 1991 269.2 3,598.2 60.6% 1992 290.3 4,001.8 64.1% 1993 255.1 4,351.0 66.0% 1994 203.2 4,643.3 66.5% 1995 164.0 4,920.6 67.0% 1996 107.4 5,181.5 67.1% 1997 21.9 5,369.2 65.3% 1998 69.3 5,478.2 63.2% 1999 125.6 5,605.5 60.8% 2000 236.2 5,628.7 57.3% 2001 128.2 5,769.9 56.4% 2002 157.8 6,198.4 58.7% 2003 377.6 6,760.0 61.5% 2004 412.7 7,354.7 62.9% 2005 318.3 7,905.3 63.6% 2006 248.2 8,451.4 63.9% 2007 160.7 8,950.7 64.5% 2008 458.6 9,986.1 69.6% 2009 1,412.7 11,875.9 85.2% 2010 1,293.5 13,528.8 94.2% 2011 1,299.6 14,764.2 98.7% Source: Council of Economic Advisers. (2012). Economic report of the president. Washington, DC: U.S. Government Printing Office. __ama80496_10_c10_279-302.indd 282 12/4/12 4:46 PM CHAPTER 10 Section 10.1? Debt and Deficits Figure 10.1: The ratio of debt to GDP, 1945?2011
20 2011 2009 2007 2005 2003 2001 1999 1997 1995 1993 1991 1989 1987 1985 1983 1981 1979 0 1977 10 Year
After falling pretty steadily until 1981, the ratio of debt to GDP climbed steadily through the 1980s
before falling slightly again in the early 1990s and then increasing again as the 2000s began. The current national debt actually understates the financial obligations of the U.S. government because of other obligations besides debt repayment that could prove costly in
the near future. The federal government has guaranteed not only the safety of deposits in
federally insured banks but also mortgage loans, student loans, and other private-sector
borrowing. Because bank failures have been higher than expected throughout the 2000s,
these guarantees have been a serious drain on the treasury. Fiscal Policy and Deficits
Critics of Keynesian fiscal policy claim that it is at least partly responsible for deficits in the
federal budget and increases in the national debt. These economists might be less opposed
to Keynesian fiscal policy if budget surpluses offset deficits over the long run. During what
might be considered the heyday of Keynesian policy?the period from 1960 to 1980?the
national debt tripled from $290.5 billion to $908.5 billion, even though the debt did decline
as a share of GDP. More recently, the national debt has increased significantly.
During the Great Depression, even before Keynes?s General Theory, there was support for
spending more on social projects during economic downturns and cutting back when the
economy returned to full employment. However, it is politically very difficult to cut back __ama80496_10_c10_279-302.indd 283 12/4/12 4:46 PM Section 10.1? Debt and Deficits CHAPTER 10 spending or increase taxes during the expansionary phase of the business cycle. Thus,
many economists fear that Keynesian policy provides a ready excuse for the long-run
expansion of the relative size of the government sector.
Households and business firms are limited in their ability to spend more than their income
for a great length of time because of the threat of bankruptcy. Bankruptcy is a remote possibility for a central government. Sometimes local governments?cities, counties, school
districts, and water systems?have been unable to pay the interest and principal on bonds
and have filed for bankruptcy. Stockton, California, made headlines in June 2012 when
it became the largest U.S. city to attempt to file for bankruptcy. The difference between
a national government and a household, firm, or local government is the power to tax a
broad range of people in order to raise funds to pay off debts. For nations, any threat of
bankruptcy comes from abroad. If a national government finances its spending through
foreign loans, then it may be unable to come up with the ?hard currency? (acceptable
foreign currencies) to repay them. This kind of bankruptcy is an important problem for a
number of countries, especially ones that have already gone bankrupt, such as Argentina
in 2001 and Iceland in 2008.
The deficits of the 1970s and 1980s were largely due to political decisions: the expansion
of spending programs and several cuts in taxes. Once spending programs are created,
they acquire clients and supporters. Thus it becomes difficult to reduce or eliminate them.
For example, it is difficult to close military bases because nearby towns will lose income
and population. The uproar over base closings in 1993, 1995, and 2005 showed that there
is great resistance to such spending cuts. Social Security and Medicare, two of the largest
categories of federal spending and previously untouchable, have seen some changes during the Obama administration. On the other hand, voting for higher taxes is also politically unpopular with both parties.
Recent budget deficits did not result primarily from discretionary fiscal policy actions
to fight recessions, but rather from perennial political problems with raising taxes and
cutting spending. The deficits and the debt are mainly the result of political decisions to
spend more than the government takes in. Only a small portion of the current national
debt is due to deficits incurred as a result of deliberate fiscal policy actions. Furthermore,
most Keynesians argue strongly that the benefits of active fiscal policy (increased employment and economic growth) more than offset the costs (budget deficits). The problem is
that many politicians have used Keynesian arguments to avoid making difficult budget
decisions. Keynes may have created a politically acceptable excuse for increasing spending without raising taxes. Key Ideas: Deficit vs. Debt
? A deficit is the amount by which the federal government?s expenditures exceed its revenues in
any given fiscal year (from October 1 to September 30).
? The national debt is the cumulative total of all past budget deficits minus all past surpluses. It is the amount owed to lenders by the federal government. __ama80496_10_c10_279-302.indd 284 12/4/12 4:46 PM Section 10.2? The Growth of the National Debt Since 1980 CHAPTER 10 10.2? The Growth of the National Debt Since 1980 B etween 1980 and 1993, budget deficits grew steadily in dollar terms, and the size of
the national debt tripled. Since 2003, the public debt has grown by more than $500
billion each year; as of July 2012, nominal U.S. GDP was $15,880 billion. The most
striking change, however, was in the ratio of debt to GDP, as shown in Table 10.1 and
Figure 10.1. That ratio reached a 10-year low in 1981 at 32.8%, only to shoot up to 72% in
1993 and to almost 100% in 2012! The current intense concern about the deficits and debt is
not based only on the fact that both are large and growing. More serious is the unpleasant
reality that both have risen much more rapidly than total output in recent years. Reagan?s Policies and the Deficit
Most of the growth in deficits in the 1980s was not based on Keynesian theory or justified
as expansionary fiscal policy. There are various ideas as to exactly what Reagan?s advisers
had in mind in 1981 when they proposed a 30% reduction in personal income taxes (and
an even bigger cut in corporate profits taxes). The actual cut in personal income taxes was
25%. Some supply-side economists argued that the increased incentives to work, save,
and invest would actually result in increased tax revenues. Although there may have been
some supply-side effects on tax revenue, they were not enough to offset the original tax
cut. A second group (including David Stockman, Reagan?s first director of the Office of
Management and Budget) argued that the purpose of the tax cut was to cut off the revenue
source that was feeding government spending. Lower revenues would force a reduction
in spending and in the size of government. This expectation was not realized, as the budget kept spending high and simply accommodated lower revenues with a larger deficit.
A third group claimed that the growth of the deficits was due not to the tax cut but to
excessive spending, which they blamed on Congress. It is true that Congress generally
did increase spending, but the budgets they received from the executive branch had large
deficits when they arrived at Congress?s doorstep.
A balanced view of the deficits of the early 1980s would suggest that they were the result
of attempting the impossible?cutting taxes while increasing defense spending and failing to control growth of income transfers, especially Social Security and Medicare. Even
attempts to reduce other categories of spending could not bridge the gap. In addition,
there were two other contributing factors. One was the recession of 1980?1982, and the
other was high interest rates. The 1980?1982 Recession
The United States entered a recession in 1980, with a sharp drop in GDP during the second
quarter. The economy then rebounded, only to see a second sharp decline in output and a
rise in unemployment in 1982. Real output fell by 2.5% in 1982, and unemployment rose
to 9.5% in 1982, remaining at that level during 1983. During the recession, the automatic
stabilizers did their job. Tax revenues fell even further than they would have with the tax
cut alone, and payments for food stamps and unemployment compensation rose. Temporarily, the deficit increased more than it would have under more normal conditions.
However, cyclical increases in the deficit are normally corrected by an ensuing expansion.
Thus, the recession can only absorb a small part of the blame for the high deficits. __ama80496_10_c10_279-302.indd 285 12/4/12 4:46 PM Section 10.2? The Growth of the National Debt Since 1980 CHAPTER 10 High Interest Rates
A second factor contributing to the deficit problem was the fact that both nominal interest
rates and real interest rates (nominal rates corrected for inflation) remained high throughout the early 1980s. From 1979 to 1983, the interest rate on a 3-month Treasury bill (a very
short-term, riskless investment) was more than 10%. Although interest rates fell in the
latter part of the 1980s, the T-bill rate was still higher than it had been for most of the preceding 3 decades.
Interest rates were slow to fall even in nominal terms. In real terms, they remained high
until the 1990?1991 recession, when first short-term rates and then longer term rates
finally began to decline. When the government borrows money, it must pay interest. Interest must be paid not only on new debt (the deficit) but on all outstanding debt as well
(the national debt). This large annual commitment of funds to interest payments makes it
much harder for the president and Congress to cut spending. Early 1990s and 2000s Recessions
The 1980s experienced a long peacetime expansion, but in the early 1990s inflation began
to rise and the Federal Reserve began to raise interest rates. These increases, combined
with the 1990 oil price shock, the debt accumulation of the 1980s, and growing consumer
pessimism, weakened growth. Together with a weakened economy, the United States
experienced a brief recession from July 1990 through March 1991. The economy quickly
recovered and continued to grow at a steady pace for the next 10 years. This ?golden era?
of the 1990s was the longest period of consistently positive growth in U.S. history. But the
economy was hit hard in early 2000. The dot-com industry sank and there was a severe
fall in business outlays and investments. Most significant, though, were the September
11, 2001, attacks on the World Trade Center in New York City. All of this brought to a
head the end of the decade of growth. Fortunately, this recession was brief and shallow.
However, within 10 years the United States saw the worst economic downturn since the
Great Depression. The Great Recession from December 2007 to June 2009 lasted a full 18
months?the longest of any recession since World War II. With the dot-com bubble and
the September 11th attacks beginning the decade, the end of the decade saw a subprime
mortgage crisis that led to the collapse of the U.S. housing bubble. In addition to this, a
global financial crisis led to the failure or collapse of many of the United States?s largest financial institutions?Bear Stearns, Fannie Mae, Freddie Mac, Lehman Brothers, and
AIG. There was also a crisis in the automobile industry. The U.S. government responded
by passing a previously unheard-of $700 billion bank bailout measure as well as a $787 billion fiscal stimulus package. The American Recovery and Reinvestment Act of 2009 was
intended to save and create jobs almost immediately, as well as provide relief for those
most affected by the recession. It also proposed to invest in the country?s infrastructure,
education, health, and green energy. Although the National Bureau of Economic Research
marked June 2009 as the end of the Great Recession, lingering effects such as high unemployment continue to plague the United States well into 2012. __ama80496_10_c10_279-302.indd 286 12/4/12 4:46 PM Section 10.2? The Growth of the National Debt Since 1980 CHAPTER 10 Efforts to Reduce the Deficit
The rapid growth of the national debt alarmed some politicians and created pressure for
restricting Congress?s unlimited ability to spend. After many years of talk about a balanced budget amendment to the Constitution, which would require a balanced budget
on an annual basis, Congress passed the Gramm?Rudman?Hollings Act in 1985. This act
set a timetable for reducing the deficit from over $200 billion in 1986 to zero in 1990.
Targets were set for each year. Failure to meet the targets would automatically trigger
painful across-the-board cuts in most federal spending programs. However, the president
and Congress were required to meet the targets only in the projected budget (based on
assumptions about economic conditions), not the actual budget.
The size of the deficits did decrease for several years, partly as a result of spending cuts
and partly due to gradual increases in tax revenues from economic growth. Part of the
deficit reduction consisted of accounting tricks, sales of assets, and increased revenues in
the Social Security trust fund. On the other hand, the unexpectedly high cost of the savings and loan bailout offset some of the other forces working to reduce the deficit.
As deficits began to rise again, President Bush reached an agreement with Congress in
1990 to reduce the deficit with a combination of tax increases and caps on spending.
However, the 1990?1991 recession and the huge cost of the savings and loan bailout
sharply increased deficits in 1989 and afterwards. By 1992, the deficit had become a serious concern in the eyes of most voters and was a central issue in the election campaign.
The outcome of that election campaign was the deficit reduction program of the Clinton
administration, a combination of tax increases and spending cuts designed to reduce the
deficit by $500 billion over a 5-year period.
The budget efforts of the 1990s departed from the Gramm?Rudman?Hollings Act of 1985.
The Budget Enforcement Act of 1990 was passed by Congress to enforce the deficit reduction accomplished by the Omnibus Budget Reconciliation Act of 1990 and also to revise
the budget control process of the federal government. These measures had the federal
budget reporting its first surplus since 1969. In 1999, that surplus nearly doubled, and
then again in 2000.
However, the early 2000s saw a dramatic increase in government spending because of
the dot-com bubble burst, the September 11th attacks, and the increase in government
spending due to military operations in Afghanistan and Iraq. These events, coupled with
a $1.35 trillion tax cut, forced the budget to return to a deficit basis. In fiscal year 2000,
the budget had a $236 billion surplus; by fiscal year 2004, it was a $413 billion deficit. By
2007, the deficit had been reduced to less than half of what it was in 2004. Unfortunately,
the economy began to enter a particularly severe recession in late 2007 and early 2008. The
credit crisis, the bankruptcy and federal takeovers of several major mortgage providers,
and a global economic downturn led to the Great Recession of 2007?2009. In an effort to
fix these economic woes, the U.S. federal government passed a series of costly economic
stimulus and bailout packages, dramatically increasing the deficit spending to nearly
unrivaled amounts. In 2009, a growing number of people became increasingly concerned
about the massive government spending. Dubbed the ?Tea Party movement,? one such
group protested in support of reducing government spending, cutting taxes, and reducing
the federal budget deficit and national debt (Wallsten & Yadron, 2010). __ama80496_10_c10_279-302.indd 287 12/4/12 4:46 PM Section 10.2? The Growth of the National Debt Since 1980 CHAPTER 10 In 2011, the United States faced a financial crisis when Treasury Secretary Timothy
Geithner notified Congress that the country would soon reach the debt ceiling previously
set at $14.294 trillion. What followed was a long and arduous debate between Democrats, Republicans, and the new
Tea Party politicians as to whether
the debt ceiling should be raised
and what would happen to the
U.S. economy without such an
increase. The U.S. debt-ceiling
crisis finally ended on July 31,
2011, when President Obama and
Speaker of the House John Boehner
reached an agreement. Signed into
law on August 2, 2011, the Budget
Control Act of 2011 immediately
increased the debt limit by $400
billion. The bill also specified $917
billion in spending cuts over 10
years, among other proposals to
further reduce government spending (Mascaro & Hennessey, 2011).
Senate Minority Leader Mitch McConnell, R-Kentucky, is
followed by reporters wanting comments as he heads back
to his Capitol Hill office after a vote on the continuing debt
crisis in July 2011. Words such as ?unprecedented? were
used to describe the debates. Three days after the signing of the
bill, the credit-rating agency Standard and Poor?s downgraded the
United States?s credit rating for
the first time to AA (from AAA).
Global markets reacted strongly, with the Dow Jones Industrial Average falling more than
5% in one day (Winslow, 2011). Although it was probably important to have a serious
discussion about the budget deficit and size of the national debt, the distasteful exchanges
and long, drawn-out process may have done more harm than good. Key Ideas: The Ever Expanding National Debt
? Public concern about federal budget deficits and debt has grown as both have risen much
more rapidly than total output in recent years.
? The United States reached its debt ceiling in 2011 and passed the Budget Control Act of 2011
to immediately increase the debt limit by $400 billion. __ama80496_10_c10_279-302.indd 288 12/4/12 4:47 PM Section 10.3? Should the Budget Be Balanced? CHAPTER 10 10.3? Should the Budget Be Balanced? T he debate over balancing the budget arises from the conflicting needs for appropriate fiscal policy and some degree of budgetary c...
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