Macroeconomic Issues Related to the Federal Deficit and the National Debt
Introduction
The US economy has been rated the largest economy in the world. In 2011, its
nominal gross domestic product was stipulated to be worth $15 trillion. This
figure was approximated to be a quarter of the nominal gross domestic product
globally. Currently, the government of the United States is working on
expanding the opportunities for economic growth, an initiative expected to take
two years.
It takes into account the challenges faced by recent fiscal budget, aiming at
reducing government spending and elimination of loopholes. In addition, it aims
at reducing unnecessary spending by few wealthier Americans and giant
corporations.
Although the Senate Budget is working on improving the situation, the
Americans are losing hope with their government. However, the Senate is
proposing for a strategic plan of laying down a strong economic foundation,
which would see job creation, replacement of sequestration, and tackling of debt
and deficits responsibly.
According to Congressional Budget Office (CBO ) (1), the economy will grow
at a slow pace due to the current changes in the budget. However, as projected
by the CBO (3), the rate of unemployment will still stand at 7 percent through
out this year. If this does not improve in 2014, then it will be longest period that
labor force will be in crisis in the past seven decades.
A nation is termed to be economically stable if it is capable of sustaining its
people in all aspects of growth ranging from employment, capital investments
and provision of basic amenities.
The US economy has maintained a stable, overall growth rate, high research
levels and investments as well as moderate rates of unemployment (Mitchell 1).
Economic growth is termed as the wealth increase of a nation’s economy. This
is achieved through capitalization growth and overall nation’s production. In
addition, this can be affected by the government economic policies and
expenditure.
In the last few decades, the world has been experiencing a credit crunch. This
has resulted to financial crisis, forcing various reserve banks and governments
interventions with an aim of curbing the economic turmoil. Credit crunch refers
to a state where interest rates are high resulting to a constrain lending to the
customers and businesses because of limited availability of cash. Credit crunch
over a period follows a recession, which may stifle the economic growth.
This happens because of a reduced capital liquidity, which in turn limits the
chances of borrowing especially from the productive sector. Inability to borrow
reduces the expansion chances leading to business stagnation. In extreme cases,
it can lead to bankruptcies and close of businesses. This eventually results to
detrimental effects on the economy and increases the rate of unemployment.
Through this, people lose their homes, assets and financial institutions collapse,
prompting central bank and government to intervene for a solution.
As noted by the CBO(4), current laws governing the federal spending and taxes
do not change but it is estimated that in 2013, there will be a shrink in budget
deficit to about $850 billion which is equivalent to 5.3 percent Gross Domestic
Product. It is also postulated that deficits will have a downward move in the few
years ahead and in 2015; the GDP will have fallen to 2.4 percent.
Although deficits are expected to have an upward trend in a decade’s time, there
are worries of maintaining the ever-rising health costs of the aging population,
increase in federal financial support to the health insurance and increasing
interests on the federal debts (Mitchell 1). This is an indication of the federal
debt remaining at a relative high rate in comparison with the economy size of
the coming years. Such debts impacts the economy negatively as increase in
interest rates raises the interest of payments on the government spending. In
addition, government-borrowing causes a reduction in savings hence contributes
to a decline in total income and capital stock.
As observed by the CBO (p.2&3), US economic growth is expected to show a
slow move in 2013 and probably show a steady upward trend in the years to
come. The current law represents monetary policies, which according to
experts; is expected to be lower than the maximum level in the next four years.
In the fourth quarter of financial year 2012, the GDP was below its potential
level, which was 6 percent. As economy is expected to adjust in 2013, rapid
growth is projected because of underlying factors of economy. According to
CBO (4), a 3.4 percent growth is expected to be realized in 2014 and this will be
followed by a 3.6 percent average in the next four years.
This means that effects of financial and housing crisis will fade as construction
of more housing units will be realized. This will encourage an increase in the
prices of stocks and credit availability. In turn, this will see a faster growth
cycle in business investments, employment, consumer spending and income.
Effects of deficit on interest rates on Government debt and on bank loans
There is also a question of effects of federal budget deficits on federal debts and
their interest rates. The effect is dependent on the upward trend of the interest
rates. However, some economists such as Friedman feel that there is a
significant effect on interest rates because of government borrowing (Hubbart,
4).
This can only be explained through a theoretical framework in describing the
effects of interest rates because of government borrowing. Interest rate affects
the level of the capital stock, which is the federal debt level (Broun 1).
What is affected by the federal budget deficit, which is equivalent to
government debt level, is the change in the rate of interest. Empirically, this
may sometimes differ significantly depending on whether debt or deficit is used.
In an empirical work point of view, the difference in specifications implies that
the deficit is reverted on interest rate levels (Seater 1).
The government can achieve economic intervention through realigning fiscal
policies. The US Government is focusing to achieve this in the next decade
through changing the taxation level and government spending. This influences
aggregate demand and the economic activity.
Reduced inflation rate and stimulated economic growth will be realized from
such an effort. On the other hand, reserve banks will achieve this through
adjusting the monitory policies in favor of businesses. In the recent years, real
estates and banking sectors have been strongly affected by the fluctuating
interest rates.
The Federal Reserve Bank has made efforts to reduce the interest rates through
changing reserve banks requirements, money supply manipulation in the open
market and changing the rate on loans to banks. The federal bank may opt to
raise the interest rate in case of inflation in an effort to improve the economic
growth (Hubbart 25).
There are other aspects, which determine the rate of interest in the credit
market. For instance, in a stable economy, the fiscal authority purchases federal
debt aiming at expansion of the money supply. This tries to maintain prices at a
constant level. As observed in the studies, federal debt held by lending
institutions such as central banks do not swarm out capital formulation in the
private sector.
For instance, over the last decades, the federal debt detained in the hands of the
public as GDP percentage kept on fluctuating from a high note of 60 percent to
a low value of about 25 percent in 1970s. The federal debt increased between
1980 and 1990 to about 50 percent GDP. However, this declined thereafter to
less than 40 percent GDP but in 2007 to 2009, this rose sharply to 60 percent
and above. This is a period when US economy experienced a financial crisis.
Empirically, studies on the federal debt and rates of interest ignore purchase of
federal debt by the central bank (Hubbart, 18). Both domestic and foreign
investors were seen to retain monetary gains that the public surrendered to the
federal government. In a bid to conduct fiscal policy, the Federal and the US
fiscal authorities held securities as assets.
Currently, the Federal Reserve holds treasury securities amounting to 11 percent
(Krugman 125). According to economists, an economy that is on recovery, the
Federal Reserve must possess treasury securities that would see expansion of
money supply as well as prevention of deflation (Mitchell 1).
Effects of deficits on short-run output
Deficit reduction tends to generate a minor negative impact on the GDP
particularly on the short run. This happens if the economy is strong and if
minimal constrains on the monetary policy were felt in the ability to handle
economic headwinds. Through reducing the short-term interest rates, the
Federal Reserve seeks to eliminate the tightened fiscal policy.
The Federal Reserve may opt to reduce the interest to low near zero in case the
outputs are below the potential levels. This means that the Federal Reserve may
not be in a position to lower the short-term interest any more in order to
eliminate the negative effects of the short-run on the GDP. This is concerning
the reduction of spending and tax increase (Thomas 1).
In case the output approaches economy’s potential for a given period, the
Federal Reserve develop measures to increase the short-term interest rates
slightly above the zero mark. When this happens, the fiscal tightening may have
no or smaller effect on GDP and unemployment.
Reduction in deficit is seen to have a little effect on the short-run output.
Deficits on short run output have an effect of ending recession but this depends
on the government spending on the money borrowed. However, failure of
government borrowing means a shortfall in productive investments. In such a
case, short-run out puts are not a means to go by. Following an economic
downturn, jobs are lost and the rate of spending decreases. Use of short run out
put deficits stimulates people’s spending hence increasing tax receipts
(Elmendorf 1).
For instance, deficits have affected the economy of the US in that this has
affected the employment sector. In the recent years, US economy has provided
employment opportunities. However, the federal deficit is at inflation since the
extensive federal spending, which is higher than its revenue adds more pressure
to the US economy. In addition, investments such as housing have also been
retarded.
Effects of deficit on Unemployment
As observed by Krugman (4), the US economy has been affected by the federal
government deficit, which touches on key pillars of the economy such as
employment. Since the era of Great Depression, America has been hard hit by
the high rates unemployment, which is seen to demoralize workers (Krugman
5).
The most worrying thing is that when one loses his/her job, he/she loses the
health insurance as well. As the rates of unemployment increases, household
spending is also affected in that families cannot make savings or pay their bills,
which in the end leads to loss of property.
In macroeconomic terms, long-term unemployment is contributed by poor
policy formulation, which is beyond anyone’s control. The long term effects of
losing a job in America is that it becomes hard to find another one and one
becomes unemployable. Surprisingly, the rate of unemployment among the
youth is higher that that of the older generation.
This means that the American workforce will be in crisis in the near future since
the older generation lacks skills and knowledge required by the modern
economy. In addition, Krugman(6) noted that there has been a fall in wages to
those in full time employment since most of the Americans have no choice but
take menial jobs, which do not match with their qualifications.
High rates of unemployment have affected families in that most of the youths
between twenty-four and thirty-four years of age are still in their parent’s hands
since their opportunities to live on their own are diminished.
The federal government expenditure has an overall effect on the Gross
Domestic Product (GDP). This is the overall performance of the economy in
terms of goods and services generated in a certain period. Government income
contributes to wages, taxes and profits realized in a fiscal year. Research
conducted by (CBO p.4) indicates that GDP will probably maintain a maximum
level, which is sustainable in the coming decade.
Between the years 2013 and 2019, the real GDP will have an upward trend of
about 2.25 percent yearly (Krugman 35). This growth is however slower than
what it experienced some years back. Furthermore, there will be a slow growth
in labor force, as baby boomers will be retiring. In addition, the rate of
unemployment will decrease to about 5.2 percent by the year 2023.
Rates of interest and inflation will however remain steady through out this
period. In this year alone, revenues are expected to have an upward trend due to
increase in taxes and income from individuals to a level of about of about 12
percent. This will be due to the increase in income on investments and taxes,
which will affect the highest taxpayers through income taxation (CBO 4).
Over the past few years, the US has recorded deviations in rates of
unemployment. This was due to changes in cost of labor as well as the political
situation. The US rate of economic growth was seen to increase in 2006 by 3.5
percent and in the subsequent year, the rate of unemployment decreased.
Since then, the US has created more jobs, estimated to be 850, 000 jobs.
However, productivity in the labor market makes the private firms give a boost
to their sales volume, and profitability ratio thus forcing the government charge
them high taxes in a bid to finance its projects.
This is seen to affect salaries and wages of most workers. The US
administration is working on policies to stabilize the growth of its economy
through lowering of taxes to multinational companies. This could see such
corporations in a position to increase salaries and wages of the workers
(Krugman 10)
Effects of deficit on inflation
Whenever the government borrows money from the public, the outstanding
debts magnitude is equivalent to its net borrowing. Government deficit is the
additional borrowing to the outstanding debt (Blogvesting 1). The deficit
records as negative upon the fall of the outstanding debt. This is also known as a
surplus.
The government owes debts mostly in terms of bonds. Long-term borrowing by
the government will mean a long-term bond, which will in turn take a long-term
payment from the time the bond was issued to the time the principal amount
will be paid back.
This may have an effect on the economy, as the whole process will see the rate
of government spending slow down hence calling for adjustments. Government
outstanding debt is adjusted through inflation. A bond value is the price of a
dollar in the market, which in turn affects the price of a commodity in the
market.
The rate of inflation increases because of faster monetary growth base than the
amount of commodities in the market. Boosting consumption rate through
deficit spending may result in inflation due to an increase in monetary base
while the amount of commodities in the economy remains unchanged. The
Obama government is in the process of laying down infrastructure that would
see an improvement in production to counter inflation and boost consumption.
This is a long-term strategic plan, which will realize employment of large
number of the work force in the next decades. It is expected that this will aid in
economy recovery by boosting of domestic production as well as reduction in
imports. Money printing by Fed should also be increased for the government to
purchase treasuries in the market to limit interest rate effects. This will focus
more on how the money is spent rather than focusing on the amount of spending
on stimulus (Blogvesting 1).
With the rising inflation, consumers are shying away from spending, and their
spending habits have changed with time. Companies are trying hard to retain
and identify new customers. This is through the provision of discounted prices
to different products and services. The methods to identify such consumers
include “those” who buy “what”, the quantity and “how often”.
This information will enable the business to identify its potential customers who
will continue buying its products despite the slow down in the economy. Such
consumers do purchase, but they are a bit cautious with what they buy hence
they buy basic goods and keep off any luxurious products.
On conclusion, deficit spending can be either way, bad or good for the
economy. This call for an immediate action especially on the effect the deficit
has on employment and inflation. What the US government is supposed to do is
to pay attention on the most effective mechanisms to spend on the stimulus
money. This is especially on the current projects that will see decreased levels
of unemployment, inflation and interest rates on money borrowed. If the federal
deficit is utilized correctly, such effects will decline over the stipulated years.
The federal government should come up with a strategy that will make people
spend more in the US through rising of import fees. Since businesses are
producing products in the overseas countries, the cost of production becomes
minimal.
Hence, imports are sold at a lower cost that products produced within the US.
Through an increase in importation fees, this would encourage businesses to
operate and invest heavily in the US thus creating employment. Another
strategy is to lower taxation, which will encourage investors to operate in the
US. This would result to workers being offered better salaries. In addition,
products and services will be affordable to the people hence reduction in the
rate of inflation.
Works Cited
Blogvesting. Will deficit spending lead inevitably to inflation? 2013. Web.
Broun, Paul. Paul Ryan’s Ax Isn’t Sharp Enough. 2013. Web.
CBO. The Budget and Economic Outlook: 2013 to 2023. 2013. Web.
Elmendorf, Doug. The Short-Term Consequences of Deficit Reduction under
Different Economic Conditions. 2013. Web.
Hubbard, Glenn. Consequences Of Government Deficits And Debt. 2013. Web.
Krugman, Paul. End this Depression Now. New York, NY: W.W. Norton &
Company, 2009. Print.
Krugman, Paul. The return of depression economics and the crisis of 2008. New
York, NY: W. W. Norton & Company. 2009. Print.
Mitchell, Bill. Deficit spending 101 – Part 3. 2013. Web.
Seater, John. Government Debt and Deficits. 2013. Web.
Thoma, Mark. Short-Run and Long-Run Deficits. 2013. Web.
