Deficits, Crowding Out, and the Burden of the Debt

Deficits, Crowding Out, and the Burden of the Debt -...

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Deficits, Crowding Out, and the Burden of the Debt 1. Two questions have to be asked about deficits: What is the size of the deficit relative to national income and for what purpose was the deficit used? Richer countries will have an easier time paying off or paying interest on any debt of a specified size. Deficits that are used to finance wars, stabilize the economy in downturns, or build projects for the future (such as the interstate highway system) are generally considered to be preferable to deficits that are incurred to just bolster consumption spending. 2. With regard to the national debt, two questions arise: Will the debt crowd out private sector spending and will the debt create a burden on future generations? Crowding Out Crowding out refers to the problem of scarcity – if the Government takes more out of our total resources, there will be less available for the private sector. When the U.S. Treasury borrows money, it accepts whatever price the market offers for the bonds it has for sale. The lower the bond price, the higher the effective interest rate. Private borrowers set limits for the interest rate they will pay and if they can not get their price, they withdraw their bonds. The result is that the U.S. Treasury is the 10,000 pound gorilla in the bond market – everyone else will get whatever is left over. Views about Crowding Out The Ricardo-Barro View of Debt Financing The Ricardo-Barro view is that U.S. Treasury borrowing does not crowd out private sector investment. Supposedly, the public realizes that they will have to pay for the increased Government debt in the future. As a result, the public reduces current consumption and increases savings. Theoretically, if higher
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This note was uploaded on 04/04/2012 for the course ECON 200H taught by Professor Staff during the Winter '11 term at Ohio State.

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Deficits, Crowding Out, and the Burden of the Debt -...

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