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slides17 - Government Debt and Monetary Policy Henning Bohn...

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Government Debt and Monetary Policy Henning Bohn University of California Santa Barbara Outline 1. Government debt: Facts and key ideas Budget deficits and debt accumulation. What limits debt and deficits? The U.S. debt-GDP Ratio: History and projections for the future. 2. Monetary policy and the public debt: Monetization and seignorage in steady state. Unexpected inflation and the role of nominal bonds. 3. U.S. Debt: The Challenge of Managing Expectations. How justified are inflation fears? Dependence on refinancing: Potential for confidence crises. Growing government obligations: Credibility at risk. 4. International perspective. And some empirical observations.
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Government Debt and Monetary Policy 2 Government Budgets: Basics Government budget deficit = Outlays – Receipts. Surplus = Receipts – Outlay. - Outlays = Spending on goods&services + Transfers + Interest on debt • Government debt = sum of accumulated past deficits. - Dynamics of debt: D(t) = D(t-1) + DEF(t). - Accounting for interest: Interest on debt(t) = i t * D(t-1) • Primary deficit = Spending + Transfers – Receipts ; excludes interest payments. - Dynamics of debt: D(t) = (1+i t ) * D(t-1) + Primary Deficit D(t) = (1+i t ) * D(t-1) - Primary Surplus • Find: Debt grows exponentially unless the primary balance is a surplus. - Primary surplus: Receipts > Spending + Transfers. - Label: “Headline deficit” = deficit with interest
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Government Debt and Monetary Policy 3 The Debt-GDP Ratio • Growing debt is a problem when it grows faster than the debtor’s ability to pay. - Government debt limited by the national tax base. Common measure: GDP - Math fact: GDP-growth reduces the debt-GDP ratio. (D/Y down when Y rises.) Change in Debt/GDP = Primary budget deficit/GDP + (Interest rate - Growth rate) * Initial Debt/GDP • History of U.S. fiscal policy: - Rising debt-GDP ratio during crises => High deficits in war and recession. - Declining debt-GDP ratio during “normal” times: Mostly due to GDP growth. • Measurement: Public Debt = Treasury securities outstanding - Gross debt = Public Debt + Securities held by trust funds (e.g. Social Security) - Trust funds have their own liabilities – need separate accounting [here omit]
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Government Debt and Monetary Policy 4 The U.S. Debt-GDP Ratio: 1792-2011
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Government Debt and Monetary Policy 5 What Limits Government Debt? Solvency : Ability to repay maturing debt. - Easy case: Maturing bonds are paid off with tax revenues. - Tricky case: Maturing bonds are repaid (in part) by issuing new bonds. Ponzi scheme : Maturing debt + interest payments always rolled into new bonds. - Verdict: Not sustainable in equilibrium with rational, forward-looking lenders. Fiscal sustainability condition
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slides17 - Government Debt and Monetary Policy Henning Bohn...

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