Reasons to Worry The fear is that interest payments tofinance the national debt will swallow an enormous helping of the federal government’s budget pie. This means future generations will pay more of their tax dollars to the government’s
GLOBAL ECONOMICS
creditors and have less to spend for highways, health care, defense, and other pub- lic-sector programs. Exhibit 6 shows net interest payments as a percentage of GDP.
The net interest payment was only about 1.5 percent of GDP right after World War II, but it increased dramatically after the mid-1970s to more than 3 percent in the mid-1980s. In 2007, the interest payment burden declined to 1.6 percent of GDP.
Reasons Not to Worry The burden of the national debt on present and future gen- erations depends on who owns the accumulated national debt. Stated more pre- cisely, the burden of the debt depends on whether it is held internally or externally.
The bulk of the public debt isinternal national debt. Internal national debt is the portion of the national debt owed to a nation’s own citizens. Internal debtfinancing is viewed as“we owe it to ourselves.”One U.S. citizen buys a government security and lends Uncle Sam the money to pay the interest and principal on a maturing government security held by another U.S. citizen. Although this redistribution of
EXHIBIT 5 A Global Comparison of National Debt Ratios, 2007
This exhibit shows the ratios of national debt to GDP in 2007 for selected industrialized countries. Japan, Italy, France, and Germany have higher debt-to-GDP ratios than the United States.
National debt as a percentage
of GDP
Japan Italy Canada United
Kingdom Country
France United Australia
States
Sweden Germany
25 50 75 100 125 150
0
72%
47%
15%
65%
46%
159%
117%
175
70%
64%
SOURCE: OECD Economic Outlook. N 82, December 2007, Annex Table 32, page 254.
Internal national debt The portion of the national debt owed to a nation’s own citizens.
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income and wealth does indeed favor bondholders, who are typically upper-income individuals, transferring dollars between U.S. citizens does not alter the overall purchasing power in the U.S. economy.
Those on the “not to worry” side of this issue also concede that an external national debtis a concern. External national debt is the portion of the national debt owed to foreign citizens. Financing the external national debt means interest and principal payments are transfers of money from U.S. citizens to other nations. If foreign governments, banks, corporations, and individual investors hold part of the national debt, the“we owe it to ourselves”argument is weakened. Exhibit 7 shows who owns the securities the U.S. Treasury has issued. In 2007, foreigners owned 25 percent of the total national debt. Fifty-two percent was held by the federal, state, and local governments, primarily by federal agencies such as the U.S. Treas- ury, the Social Security Administration, and Federal Reserve banks. The Federal Reserve is an independent government agency, as explained in the next chapter. The private sector, consisting of individuals, banks, corporations, and insurance compa- nies, held 23 percent of the national debt. The debt held by the private sector and government entities constitutes the internal national debt.
Although 75 percent of the national debt was internal, the 25 percent of total U.S. debt that is external debt is not necessarily undesirable. Foreign investment in the United States supplements domestic saving. Borrowing from abroad can prevent
EXHIBIT 6 Federal Net Interest as a Percentage of GDP, 1940--2007
Some fear that interest payments on the national debt will swallow an enormous portion of the federal budget. The exhibit shows that the net interest payment as a proportion of GDP was only about 1.5 percent right after World War II. In the 1980s and early 1990s, however, the interest rate burden increased dramatically. Since 1995, it declined to 1.6 percent of GDP in 2007.
Net interest as a percentage
of GDP
Year 3.0
3.5
2.5 2.0 1.5 1.0 0.5 0
1940 1950 1960 1970 1980 1990 2000 2010
SOURCE: Economic Report of the President, 2008, http://www.gpoaccess/eop/, Tables B-1 and B–80.
External national debt The portion of the national debt owed to foreign citizens.
the higher interest rates that would exist if the U.S. Treasury relied only on domestic savers to purchase federal government securities. A lower interest rate increases U.S. investment and consumer spending, causing the aggregate demand curve to shift rightward.
If we do not need to worry about shifting the burden to future generations, can the current generation escape the debt burden? The answer is No. During World War II, for example, the United States operated at full employment along itspro- duction possibilities curve.As illustrated earlier in Exhibit 2 of Chapter 2, the peo- ple at that time in history were forced to trade off consumer goods production for military goods production. Because massive amounts of resources were diverted to fight World War II, people at that time were forced to give up private consumption of houses, cars, refrigerators, and so on. After the war was over, resources were again devoted to producing more consumer goods and fewer military goods. The same analysis can be used today. At full employment, the burden of the national debt on the current generation is the opportunity cost of private-sector goods for- gone because land, labor, and capital are used to produce public-sector goods.
In other words, the burden of the national debt is incurred when production takes place; it is not postponed until the debt is paid by future generations. When the debt comes due in the future, the government can simply refinance the debt and redistribute money from one group of citizens to another. This redistribution of income does not cause a reallocation of resources away from consumer goods and services in favor of government programs.
EXHIBIT 7 Ownership of the National Debt, 2007
In 2007, about 52 percent of the national debt was held by the public sector, including federal, state, and local governments and Federal Reserve banks. The private sector, including individuals, banks, corporations, and insurance companies, held 23 percent, and foreigners owned the remaining 25 percent.
Foreigners 25%
Private-Sector Debt Individuals, banks, corporations, and insurance companies Public-Sector Debt 23%
Federal, state, and local governments
and Federal Reserve banks
52%
SOURCE: Economic Report of the President, 2008, http://www.gpoaccess.gov/eop/, Table B-89.
340 PA RT 4 MACROECONOMIC THEORY AND POLICY