Note: This post was originally published in August of 2010. It is being reposted today to support a lesson on fiscal policy in my year 2 IB Economics class.
In the seemingly endless and currently ongoing debate over the role of the government in the macroeconomy, there are two main camps: Those who think the governments of the developed economies have not done enough to get their economies out of recession, and those who think they have already done too much, and therefore need to start rolling back stimulus and reducing deficits.
At the heart of this debate are the two macroeconomic schools of thought, the Keynesian demand-side theories and the classical, supply-side theories. Two intellectuals have emerged in the last several years representing the two sides of the macroeconomic debate. On the demand-side, representing the Keynesian school of thought, is 2008 Nobel Prize winning economist Paul Krugman. Representing the classical, supply-side school of thought is Harvard economic historian Niall Ferguson. These two have squared off in many forums over the last three years, Krugman arguing for more and continued fiscal stimulus to prop up and increase demand in the economy, Ferguson arguing for smaller deficits, lower taxes and less government spending to increase private sector confidence and thereby supply in the economy.
During our long summer break the two squared off once again in the aftermath of a G20 meeting in which the governments of several major economies from Europe and North America announced plans to begin rolling back the stimulus spending they embarked on throughout 2008 and 2009. The reason for increased “austerity measures” (policies that reduce the budget deficit and slow the growth of national debt), argue global leaders, is to reduce the chances of more countries experiencing debt crises like that experienced in Greece this spring.
International investors realized earlier this year that Greece’s budget deficits were a much larger percentage of its GDP than previously thought, and very quickly decided that Greek government bonds were an unsafe investment. Almost overnight the cost of borrowing in Greece shot up above 20%, bringing investment in the economy to a halt and forcing the government to cut its budget, leading to higher unemployment and reduced social benefits for the people of Greece. If investors were to look at the growing budget deficits in other developed countries and then suddenly lose faith in other government’s ability to pay back their debts, then a similar crisis could occur in much larger economies, including the UK, Germany and the United States. Hence these country’s apparent desire to begin reducing deficits and rolling back stimulus spending; measures that may just plunge these economies into an even deeper recession than that which they have experienced over the last two years.
The videos below show the leading intellectuals on both sides of the stimulus/austerity debate presenting their arguments. Below each video are discussion questions to help guide your understanding of their views. Watch the videos and respond to the discussion questions in the comment section below.
Fiscal policy consists of the use of taxes and government spending in the economy to promote macroeconomic objectives such as full employment, economic growth, low inflation and reduced income inequality. When an economy is doing poorly, the government’s fiscal policies tend to result in large budget deficits, which occur when the amount of expenditures exceed the amount of tax revenue collected in a particular year.
When a government runs deficits year after year, each deficit is added to the nation’s debt. The charts below, created using Google’s Public Data Explorer, provide a snapshot of the deficit and debt situations experienced by the countries of Europe over the last couple of decades. Study the graphs closely with your class, then read the analysis and explanations that follow!
When an economy is doing well, fiscal policy adjusts automatically to bring down deficits, and even allow a government to run a budget surplus if the tax revenues exceed government expenditures. When the economy slows down, output falls, and unemployment rises, government spending and taxation automatically adjust in ways that move the budget towards deficit, in which the government spends more than it collects in taxes.
These automatic adjustments to fiscal policy result from the effect growth or recession have on previously mandated government expenditures and tax receipts. For example, imagine the US economy slips into a recession:
As demand for the nation’s output falls, the incomes of producers and workers decline, therefore the amount of income tax received by the government decreases automatically
At the same time, more workers are becoming unemployed, making them eligible to receive unemployment benefits from the government. More people slip into poverty and begin to receive welfare and government health insurance, and perhaps even subsidized housing and food.
Revenues automatically decline while government spending automatically increases, moving the budget further into deficit.
Next imagine the US economy has recovered and is growing at rates above its long run average growth rate. During such “booms” in the business cycle, the following occurs:
Business and household incomes are rising, so more income tax is being paid, increasing government tax revenues.
Unemployment is falling, meaning fewer people receive government benefits. Fewer people are in poverty, meaning less spending on transfer payments that support the poor.
With tax revenues increasing and government transfer payments decreasing, the budget automatically moves towards surplus.
These “automatic stabilizers” should mean that as an economy experiences the normal fluctuations of its business cycle, the government budget fluctuates between surpluses and deficits, and over time, national debt is kept nice and low. But as we saw in the graphs linked in the top of this post, a sustained downturn in economic activity can lead to structural deficits that persist for years and years. Persistent budget deficits mean an ever ballooning national debt, as can be seen in this chart:
As the graph above shows, over time, large deficits lead to ever growing debts. Notice the general inverse relationship between the size of a country’s budget deficit and the size of its national debt. Countries in the upper left hand corner of the graph generally have low deficits (or budget surpluses) and enjoy relatively small national debts. In the lower right, on the other hand, large deficits have lead to levels of debt frighteningly large as a percentage of the countries’ GDPs.
Discretionary Fiscal Policy
What does all this mean for government policy makers? Let’s first distinguish between the automatic fiscal policy described above and discretionary fiscal policy. Much of the increase in budget deficits and national debts seen in the charts in this post can be explained by European governments’ initial responses to the economic downturns first seen in 2007 and 2008. When unemployment began to rise and output began to fall across Europe, the first response of many governments was to intervene to try to stimulate aggregate demand beyond what was provided automatically through increased transfer payments and decreasing tax receipts. Discretionary fiscal policy refers to deliberate changes to overall tax rates and government spending aimed at directly or indirectly stimulating (or contracting) demand in the economy to help move an economy back to its full employment level during a recession (or, in some cases, during a period of high inflation).
Discretionary fiscal policy, when used during a recession, will drastically increase the size of a budget deficit (and therefore, the national debt). Why do it, you ask? Advocates of such policies (often known as Keynesians, after John Maynard Keynes, whose theories formed the basis for such policies) argue that a recession must be reversed as soon as possible, or else the burden of a nation’s existing debt will grow (as a percentage of its GDP) as the country’s GDP falls. More importantly, of course, is the human and social cost of a recession, as workers become unemployed and hardship spreads among the nation’s households.
A short-term increase in the budget deficit may pay for itself if the subsequent increase in overall demand is mulitplied throughout the economy and overall GDP increases by more than it would have with only automatic stabilizers to rely on. Government spending on infrastructure, education, health, and other public goods creates jobs, increases household income, provides the economy with new capital and infrastructure, increasing the nation’s production possibilities and boosting demand to move the economy closer to full employment. Higher incomes among those employed in government projects will be spent, creating even more new jobs in the private sector.
Discretionary fiscal policy aimed at stimulating demand requires a government borrows money, increasing the national debt. But if such policies are successful, the debt burden will be smaller over time since economic growth may return, increasing the GDP and thus allowing the budget to move back towards surplus sooner, as automatic stabilizers once again kick in.
Evaluating the use of Fiscal Policy for managing the economy
Understanding the difference between automatic and discretionary fiscal policy, and the impact that expansionary policies have on budget deficits and national debt, provide us with tools for evaluating its use during recessions or periods of high inflation. However, we need to know more about the impact of deficits and debt in order to fully evaluate its use. For that, you’ve got to read some more posts and watch some videos. Here are some key resources that will help you evaluate the use of fiscal policy for fighting recessions.
After watching these two video lectures and reading the post, answer the discussion questions that follow:
Explain the huge increases in national debts (both in Euros and as percentages of the countries GDPs) during the later part of the decade from 2000 to 2010.
How does automatic fiscal policy differ from discretionary fiscal policy?
How does the multiplier effect of fiscal policy provide support to the Keynesians’ views that tax cuts and increases in government spending can highly effective at getting and economy out of recession?
How does the crowding-out effect of fiscal policy support the opponents of its use who argue that government spending and tax cuts will only make an economy less competitive and grow more slowly in the long-run?
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As yet another school year begins, we once again find ourselves returning to an atmosphere of economic uncertainty, sluggish growth, and heated debate over how to return the economies of the United States and Europe back onto a growth trajectory. In the last couple of weeks alone the US government has barely avoided a default on its national debt, ratings agencies have downgraded US government bonds, global stock markets have tumbled, confidence in the Eurozone has been pummeled over fears of larger than expected deficits in Italy and Greece, and the US dollar has reached historic lows against currencies such as the Swiss Franc and the Japanese Yen.
What are we to make of all this turmoil? I will not pretend I can offer a clear explanation to all this chaos, but I can offer here a little summary of the big debate over one of the issues above: the debate over the US national debt and what the US should be doing right now to assure future economic and financial stability.
There are basically two sides to this debate, one we will refer to as the “demand-side” and one we will call the “supply-side”. On the demand-side you have economists like Paul Krugman, and in Washington the left wing of the Democratic party, who believe that America’s biggest problem is a lack of aggregate demand.
Supply-siders, on the other hand, are worried more about the US national debt, which currently stands around 98% of US GDP, and the budget deficit, which this year is around $1.5 trillion, or 10% of GDP. Every dollar spent by the US government beyond what it collects in taxes, argue the supply-siders, must be borrowed, and the cost of borrowing is the interest the government (i.e. taxpayers) have to pay to those buying government bonds. The larger the deficit, the larger the debt burden and the more that must be paid in interest on this debt. Furthermore, increased debt leads to greater uncertainty about the future and the expectation that taxes will have to be raised sometime down the road, thus creating an environment in which firms and households will postpone spending, prolonging the period of economic slump.
The demand-siders, however, believe that debt is only a problem if it grows more rapidly than national income, and in the US right now income growth is almost zero, meaning that the growing debt will pose a greater threat over time due to the slow growth in income. Think of it this way, if I owe you $98 and I only earn $100, then that $98 is a BIG DEAL. But if my income increases to $110 and my debt grows to $100, that is not as big a deal. Yes, I owe you more money, but I am also earning more money, so the debt burden has actually decreased.
In order to get US income to grow, say the demand-siders, continued fiscal and monetary stimulus are needed. With the debt deal struck two weeks ago, however, the US government has vowed to slash future spending by $2.4 trillion, effectively doing the opposite of what the demand-siders would like to see happen, pursuing fiscal contraction rather than expansion. As government spending grows less in the future than it otherwise would have, employment will fall and incomes will grow more slowly, or worse, the US will enter a second recession, meaning even lower incomes in the future, causing a the debt burden to grow.
Now let’s consider the supply-side argument. The supply-siders argue that America’s biggest problem is not the lack of demand, rather it is the debt itself. Every borrowed dollar spent by the goverment, say the supply-siders, is a dollar taken out of the private sector’s pocket. As government spending continues to grow faster than tax receipts, the government must borrow more and more from the private sector, and in order to attract lenders, interest on government bonds must be raised. Higher interest paid on government debt leads to a flow of funds into the public sector and away from the private sector, causing borrowing costs to rise for everyone else. In IB and AP Economics, this phenomenon is known as the crowding-out effect: Public sector borrowing crowds out private sector investment, slowing growth and leading to less overall demand in the economy.
Additionally, argue the supply-siders, the increase in debt required for further stimulus will only lead to the expectation among households and firms of future increases in tax rates, which will be necessary to pay down the higher level of debt sometime in the future. The expectation of future tax hikes will be enough to discourage current consumption and investment, so despite the increase in government spending now, the fall in private sector confidence will mean less investment and consumption, so aggregate demand may not even grow if we do borrow and spend today!
This debate is not a new one. The demand-side / supply-side battle has raged for nearly a century, going back to the Great Depression when the prevailing economic view was that the cause of the global economic crisis was unbalanced budgets and too much foreign competition. In the early 30’s governments around the world cut spending, raised taxes and erected new barriers to trade in order to try and fix their economic woes. The result was a deepening of the depression and a lost decade of economic activity, culminating in a World War that led to a massive increase in demand and a return to full employment. Let’s hope that this time around the same won’t be necessary to end our global economic woes.
Recently, CNN’s Fareed Zakaria had two of the leading voices in this economic debate on his show to share their views on what is needed to bring the US and the world out of its economic slump. Princeton’s Paul Krugman, a proud Keynesian, spoke for the demand-side, while Harvard’s Kenneth Rogoff represented the supply-side. Watch the interview below (up to 24:40), read my notes summarizing the two side’s arguments, and answer the questions that follow.
Summary of Krugman’s argument:
Despite the downgrade by Standard & Poor’s (a ratings agency) there appears to be strong demand for US government bonds right now, meaning really low borrowing costs (interest rates) for the US government.
This means investors are not afraid of what S&P is telling them to be afraid of, and are more than happy to lend money to the US government at low interest rates.
Investors are fleeing from equities (stocks in companies), and buying US bonds because US debt is the safest asset out there. The market is saying that the downgrade may lead to more contractionary policies, hurting the real economy. Investors are afraid of contractionary fiscal policy, so are sending a message to Washington that it should spend more now.
The really scary thing is the prospect of another Great Depression.
Can fiscal stimulus succeed in an environment of large amounts of debt held by the private sector? YES, says Krugman, the government can sustain spending to maintain employment and output, which leads to income growth and makes it easier for the private sector to pay down their debt.
With 9% unemployment and historically high levels of long-term unemployment, we should be addressing the employment problem first. We should throw everything we can at increasing employment and incomes.
Is there some upper limit to the national debt? Krugman says the deficit and debt are high, but we must consider costs versus benefits: The US can borrow money and repay in constant dollars (inflation adjusted) less than it borrowed. There must be projects the federal government could undertake with at least a constant rate of return that could get workers employed. If the world wants to buy US bonds, let’s borrow now and invest for the future!
If we discovered that space aliens were about to attack and we needed a massive military buildup to protect ourselves from invasion, inflation and budget deficits would be a secondary concern to that and the recession would be over in 18 months.
We have so many hypothetical risks (inflation, bond market panic, crowding out, etc…) that we are afraid to tackle the actual challenge that is happening (unemployment, deflation, etc..) and we are destroying a lot of lives to protect ourselves from these “phantom threats”.
The thing that’s holding us back right now in the US is private sector debt. Yes we won’t have a self-sustaining recovery until private sector debt comes down, at least relative to incomes. Therefore we need policies that make income grow, which will reduce the burden of private debt.
The idea that we cannot do anything to grow until private debt comes down on its own is flawed… increase income, decrease debt burden!
Things that we have no evidence for that are supposed to be dangerous are not a good reason not to pursue income growth policies.
When it comes down to it, there just isn’t enough spending in the economy!
Summary of Rogoff’s argument:
The downgrade was well justified, and the reason for the demand for treasuries is that they look good compared to the other options right now.
There is a panic going on as investors adjust to lower growth expectations, due to lack of leadership in the US and Europe.
This is not a classical recession, rather a “Great Contraction”: Recessions are periodic, but a financial crisis like this is unusual, this is the 2nd Great Contraction since the Depresssion. It’s not output and employment, but credit and housing which are contracting, due to the “debt overhang”.
If you look at a contraction, it can take up to 4 or 5 years just to get back where you started.
This is not a double dip recession, because we never left the first one.
Rogoff thinks continued fiscal stimulus would worsen the debt overhang because it leads to the expectation of future tax increases, thus causing firms and households increased uncertainty and reduces future growth.
If we used our credit to help facilitate a plan to bring down the mortgage debt (debt held by the private sector), Rogoff would consider that a better option than spending on employment and output. Fix the debt problem, and spending will resume.
Rogoff thinks we should not assume that interest rates of US debt will last indefinitely. Infrastructure spending, if well spent, is great, but he is suspicious whether the government is able to target its spending so efficiently to make borrowing the money worthwhile.
Rogoff thinks if government invests in productive projects, stimulus is a good idea, but “digging ditches” will not fix the economy.
Until we get the debt levels down, we cannot get back to robust growth.
It’s because of the government’s debt that the private sector is worried about where the country’s going. If we increase the debt to finance more stimulus, there will be more uncertainty, higher interest rates, possibly inflation, and prolonged stagnation in output and incomes.
When it comes down to it, there is just too much debt in the economy!
What is the fundamental difference between the two arguments being debated above? Both agree that the national debt is a problem, but where do the two economists differ on how to deal with the debt?
The issues of “digging ditches and filling them in” comes up in the discussion. What is the context of this metaphor? What are the two economists views on the effectiveness of such projects?
Following the debate, Fareed Zakaria talks about the reaction in China to S&P’s downgrade of US debt. What does he think about the popular demands in China for the government to pull out of the market for US government bonds?
Explain what Zakaria means when he describes the relationship between the US and China as “Mutually Assured Destruction (MAD)”.
Should the US government pursue a second stimulus and directly try to stimulate employment and income? Or should it continue down the path to austerity, cutting government programs to try and balance its budget?
I received the following email from an Econ teacher who wonders if I had any insight on a question posed by one of his students:
The email reads: “I have alittle query i was hoping you could help clear up for me..a year 13 student has asked a question relating to Argentina’s prime minister, Cristina Fernandezde De Kirchner’s, decision to sell the central bank’s dollar reserves to fund part of the country’s decifit against the advice of the director of the central bank who resigned.”
The student’s question is on the following passage from the Economist article above:
Fernández (Argentina’s president”) justified her raid on the reserves by saying that the Central Bank had more than it needed, because they exceeded the size of the monetary base. Economists disagree about what is an appropriate target for the reserves, but Mr Redrado’s view is that a highly dollarised emerging economy like Argentina’s needs an abundance of Treasury bonds (the form in which most reserves are held) as insurance. Even if Ms Fernández might find support from some economists for her argument, her plan to swap the dollar reserves for a non-transferable government bond would not.
The student’s question is: “I do not know what a monetary base is, nor why Argetina needs treasury bonds.”
This article really caught me off guard at first as well. One thing I love about the Economist newspaper is its use of economic jargon that requires a real understanding of the subject to be able to interpret. The first time I read the article, I will be honest I was completely confused as to what the Argentinean president was up to. But after some reflection and rough sketches of graphs on scrap paper, I think I have “translated” the article’s jargon into plain English.
Below is my reply to the teacher and his student:
The president of Argentina wants to sell the country’s US dollar reserves, which are held in the form of US treasury bonds, and then use the US dollars she receives to buy Argentinean government bonds in order to finance her own government’s budget deficit. In essence she wants to swap Argentina’s central bank reserves of US debt (considered a very stable and safe asset due to America’s low inflation rate and relative solvency of the US government) for Argentinean government debt (less stable and safe, especially in the wake of the country’s 2002 default on its debt). Argentina’s central bank would then hold fewer transferable, stable US bonds and more “non-transferable”, Argentinean government bonds. And since the bonds represent Argentina’s government debt, the country as a whole reduces its assets and increases its liabilities.
It is important for a developing country like Argentina to keep large reserves of US dollar-denominated assets (i.e. US treasury bonds) in reserve in order to assure foreign investors that the country would be able to stabilize its currency’s value in the face of a currency crisis such as that which Argentina experienced in 2001-2002. If the value of the peso began to decline on foreign exchange markets (due, for instance, to a decline in international investor confidence in the government’s ability to pay the interest on its foreign debt or inflation fears caused by excessive monetary growth or government spending) then the central bank could use its large dollar reserves to intervene in the forex market and stabilize the value of the peso, reestablishing investor confidence and maintaining the government’s ability to attract foreign creditors in the Argentinean bond market. A collapse of the peso would have ripple effects throughout Argentina, driving up imported products and raw materials and causing spiraling inflation, forcing the government to print more money to finance its budget in the face of falling demand for its debt in domestic and international bond markets.
Argentina must be sure to keep its balance sheet (i.e. its liability to asset ratio) in check. Its assets are US government bonds, its liabilities are the Argentinean bonds it issues to finance its budget deficits. If this ratio become too heavy on the liability side, foreign investors and speculators will lose confidence in the both peso and the Argentinean government’s solvency and dump their holdings of Argentinean currency, assets, and bonds, driving interest rates through the roof and the exchange rate through the floor, grinding the economy to a halt.
The article says,
Argentina’s economy is on course to rebound this year and grow at 3-5%. But the government is spending money so fast that this growth will not finance current spending on its own, says Daniel Marx, a former finance minister. Ordinarily, a government faced with a shortfall would turn to domestic and international bond markets. But this has been difficult since Argentina defaulted in 2002.
The country cannot count on private creditors to make up its budget shortfall, so the president is planning to finance her country’s deficit by buying Argentinean bonds with the country’s own US dollar reserves. Such behavior concerns economists because it could send a message to international investors that the country is on the path towards another unsustainable build-up of debt that could culminate in another default and economic collapse. The article is a word of caution to the president that all leaders should heed: balanced budgets are a good idea, and debt is dangerous!
Harvard Economist Niall Ferguson appeared on CNN’s GPS with Fareed Zakaria over the weekend. Ferguson has stood out among mainstream economists lately in his opposition to the US fiscal stimulus package, an $880 billion experiment in expansionary Keynesian policy. While economists like Paul Krugman argue that Obama’s plan is not big enough to fill America’s “recessionary gap”, Ferguson warns that the long-run effects of current and future US budget deficits could lead the US towards economic collapse. This blog post will attempt to explain Ferguson’s views in a way that high school economics students can understand.
Government spending in the US is projected to exceed tax revenues by $1.9 trillion this year, and trillions more over the next four years. An excess of spending beyond tax revenue is known as a budget deficit, and must be paid for by government borrowing. Where does the government get the funds to finance its deficits? The bond market. The core of Ferguson’s concerns about the future stability of the United States economy is the situation in the market for US government bonds. According to Ferguson:
One consequence of this crisis has been an enormous explosion in government borrowing, and the US federal deficit… is going to be equivelant to 1.9 trillion dollars this year alone, which is equivelant to nearly 13% of GDP… this is an excessively large deficit, it can’t all be attributed to stimulus, and there’s a problem. The problem is that the bond market… is staring at an incoming tidal wave of new issuance… so the price of 10-year treasuries, the standard benchmark government bond… has taken quite a tumble in the past year, so long-term interest rates, as a result, have gone up by quite a lot. That poses a problem, since part of the project in the mind of Federal Reserve Chairman Ben Bernanke is to keep interest rates down“
There’s a lot of information in Ferguson’s statements above. To better understand him, some graphs could come in handy. Below is a graphical representation of the US bond market, which is where the US government supplies bonds, which are purchased by the public, commercial banks, and foreigners. Keep in mind, the demanders of US bonds are the lenders to the US government, which is the borrower. The price of a bond represents the amount the government receives from its lenders from the issuance of a new bond certificate. The yield on a bond represents the interest the lender receives from the government. The lower the price of a bond, the higher the yield, the more attractive bonds are to investors. Additionally, the lower the price of bonds, the greater the yield, thus the greater the amount of interest the US government must pay to attract new lenders.
Ferguson says that the price of US bonds has “taken a tumble”. The increase of supply has lowered bond prices, increasing their attractiveness to investors who earn higher interest on the now cheaper bonds. Below we can see the impact of an increase in the quantity demanded for government bonds on the market for private investment.
Financial crowding-out can occur as a result of deficit financed government spending as the nation’s financial resources are diverted out of the private sector and into the public sector. Granted, during a recession the demand for loanable funds from firms for private investment may be so low that there is no crowding out, as explained by Paul Krugman here.
But crowding out is not Ferguson’s only concern. The increase in interest rates caused by the US government’s issuance of new bonds could lead to a decrease in private investment in the US economy, inhibiting the nation’s long-run growth potential. But the bigger concern is one of America’s long-run economic stability. If the Obama administration does not put forth a viable plan for balancing its budget very soon, the demand for US government bonds could fall, which would further excacerbate the crowding-out effect, and eliminate the country’s ability to finance its government activities. In other words, such a loss of faith could plunge the United States into bankruptcy.
Fareed Zakaria asks Ferguson:
“Is it fair to say that this bad news, the fact that we can’t sell our debt as cheaply as we thought, overshadows all the good news that seems to be coming?”
The green shoots that are out there (referring to the phrase economists and politicians have been using to describe the signs of recovery in the US economy) seem like tiny little weeds in the garden, and what’s coming in terms of the fiscal crisis in the United States is a far bigger and far worse story.
Finally Fareed asks the question everyone wants to know:”What the hell do we do?”
One thing that can be done very quickly is for the president to give a speech to the American people and to the world explaining how the administration proposes to achieve stabilization of American public finance… the administration doesn’t have that long a honeymoon period, it has very little time in which it can introduce the American public to some harsh realities, particularly about entitlements and how much they are going to cost. If a signal could be sent really soon to the effect that the administration is serious about fiscal stabilization and isn’t planning on borrowing another $10 trillion between now and the end of the decade, then just conceivably markets could be reassured.
Ferguson is saying that only if the Obama administration begins taking serious steps towards balancing the US government’s budget can it hope to stave off an eventual loss of faith among America’s creditors (and thus a fall in demand for US bonds). It will be a while before tax revenues are high enough to finance the US budget. But if the country does not begin working towards such an end immediately, it may find itself unable to raise the funds to pay for such public goods as infrastructure, education, health care, national defense, medical research, as well as the wages of the millions of government employees. In other words, the US government could be bankrupt, and its downfall could mean the end of American economic power.
The power of the bond market should not be underestimated. America’s very future depends on continued faith in its financial stability and fiscal responsibility.
Why do you think the US government has such a huge budget deficit this year? ($1.9 trillion) Previously, the largest budget deficit on record was only around $400 billion.
How does the issuance of new bonds by the US government lead to less money being available to private households and firms?
Do you think investors will ever totally lose faith in US government bonds? Why or why not?
In what way is the government’s huge budget deficit a “tax on teenagers”? In other words, how will today’s teenagers end up suffering because of the federal budget deficit?
To learn more about the power of the bond market, watch Niall Ferguson’s documentary, The Ascent of Money. The section on the bond market can be viewed here: