A Quick and Easy Debt and Deficit Primer

What is the federal deficit?

The federal deficit is the amount by which federal government spending exceeds revenues in a particular year. It is the additional amount that the government has to borrow each year.

How big is the federal deficit?

In fiscal year 2012 (which ended Sept. 30), the deficit was about $1.1 trillion.

What is the Public Debt?

The public debt is the total amount owed by the U.S. government. It is the net total of all deficits and surpluses the government has had since the country began, or the total amount that the government has borrowed.

How big is the Public Debt?

As of Jan. 3, 2013, the total public debt was just over $16.4 trillion.

What’s the difference between the Public Debt and the “Debt Held by the Public”?

Much of the public debt is held by the Federal Reserve and governmental bodies. Because this effectively is money that the government owes to itself, the amount of debt owed to others is much more important to look at. This is the “debt held by the public”.

How big is the Public Debt Held by the Public?

As of Jan. 3, 2013, the debt held by the public was about $11.6 trillion.

What’s the best way to measure the public debt?

The most useful way to measure the public debt is to look at the public debt held by the public as a percentage of Gross Domestic Product (GDP, or the total size of the economy). The debt held by the public is about 76% of GDP. The 2012 federal deficit was about 7.2% of GDP.

Who holds the public debt?

The largest chunk of debt is held by the Fed and governmental agencies. About a third is held by foreign governments and firms and investors in other countries. About 12% is held by U.S. mutual funds, private pension funds, and insurance companies. State and local governments hold about 3%.

What foreign countries hold the public debt?

The U.S. owes China about $1.1 trillion, about 21% of our total debt. We owe Japan another $1.1 trillion. Oil exporting countries (Saudi Arabia, Kuwait, Iraq, Venezuela, Indonesia, and others) hold about $260 billion. Brazil holds $250 billion. About $240 billion is held by “Caribbean Banking Center” countries (Bahamas, Bermuda, Cayman Islands, etc.).

When do we have to pay it all back?

True fact: The U.S. government never really has to pay back the public debt. As long as the debt doesn’t get “too big”, the government can keep borrowing to pay off older debt. However, the government does have to keep paying interest on all the money it owes.

How much interest are we paying?

We paid about $220 billion in interest in 2012. This was about 6% of total federal government spending.

How big is too big?

There’s no simple answer. The bigger the debt, the more interest we have to pay, the more likely it is that the government will have trouble borrowing more, and the more likely the debt will hurt the economy. Some research suggests that debt hurts growth when it gets over 90% of GDP, but opinions vary. However, if the public debt grows more slowly than the economy, the debt becomes smaller and smaller relative to GDP, and so becomes less and less important.

Are deficits bad for the country? What do economists say?

Economists differ on their views of deficits. Most economists agree that deficit spending (“fiscal stimulus”) during recessions is a good thing overall, for a number of good reasons. Few economists would argue that deficit spending during economic expansions is generally a good idea.

How much did the federal government spend in 2012? How much did it take in?

The federal government spent about $3.7 trillion in 2012, and revenues were about $2.6 trillion. Spending was about 25% of GDP, and revenues were about 17%.

Some Final Comments

Everything in economics is a trade-off. Deficit spending stimulates the economy in the short term, but has implications for the long term. When an economy has high unemployment, deficit spending can help to get people back to work, which eventually increases tax revenues. This can actually reduce future deficits. Thus, helping the economy in the short term can help in the long term as well, despite the long-term negatives of owing more money. But again, this is complicated stuff and opinions differ on the specifics.

The “Fiscal Cliff” is Really a Slope

I wrote earlier about how the “Fiscal Cliff” is a bad name for it. It’s really a slope, albeit one with increasing steepness. Unless fear turns it into a chasm.

This is from the Associated Press:

“If New Year’s Day arrives without a deal, the nation shouldn’t plunge onto the shoals of recession immediately. There still might be time to engineer a soft landing.

So long as lawmakers and the president appear to be working toward agreement, the tax hikes and spending cuts could mostly be held at bay for a few weeks. Then they could be retroactively repealed once a deal was reached.

The big wild card is the stock market and the nation’s financial confidence: Would traders start to panic if Washington appeared unable to reach accord? Would worried consumers and businesses sharply reduce their spending? In what could be a preview, stock prices around the world dropped Friday after House Republican leaders’ plan for addressing the fiscal cliff collapsed.”

 

 

Ask an Economist: Why do prices have to go up?

Why is it inevitable that prices go up? In other words, why do we just /assume/ that it makes sense for everything to cost twenty (or so) times today what it cost a hundred years ago?

In theory, the Fed could try and manage the money supply in a way that tries to hit a 0 percent inflation mark. But there are lots of problems with this, and aiming instead for a 2 to 2-and-a-half rate arguably has advantages.

First, it’s important to realize that managing the money supply with regard to inflation is an imperfect science. It’s like trying to steer an aircraft carrier looking out of a warped and blurry porthole. It takes months to turn the ship, CPIand you’re never sure of what ahead or what the currents really look like. Even with some of the best macroeconomic minds in the business working on this full-time, it’s impossible to anticipate everything that could happen.

A big problem with aiming for 0 percent inflation is that there’s a big risk that at some point you’d have deflation, when prices are actually decreasing. This might sound like a good thing, but it’s actually traumatic for an economy – just ask Japan. If consumers believe that prices will be lower next month than they are today, they delay purchases – which can lead to even more deflation. When 70 percent of GDP is driven by consumers, this can be devastating for the economy and lead to prolonged recessions and higher unemployment.

Another point to remember is that when average prices are rising by 2 percent a year, some prices are rising much more, and some are actually falling. This is always the case. The inflation numbers reported in the news are just the overall, Price Changes by Categoryweighted averages for urban consumers. There’s always actual deflation occurring in some product categories, and depending on what you buy, the average prices you pay could actually be decreasing overall.

There’s also an (arguable) advantage to having prices increase by 2 or 3 percent a year. This allows employers to give some workers pay cuts by holding their (nominal) wages constant. This actually can be helpful to the economy in declining industries, or with poorly-performing workers. It’s very difficult to give employees actual (nominal) pay cuts, even when it’s necessary and appropriate. Having inflation allows employers to freeze wages and give employees (real) pay cuts. The workers know what’s happening, of course, but they’re less likely to riot than they would be if their nominal wages were cut.

Finally, having low, steady rates of inflation do very little harm to an economy. Borrowers, lenders, firms, consumers, and everyone else expects prices to rise by small amounts, and they build them into prices, contracts, and decisions. The small “menu costs” involved with changing prices every year or so are a small price to pay for the relative advantages of having low inflation.

Two Lines Diverge in a Labor Graph

I came across this graph in a paper* the other day, and I found it rather disturbing (yeah, economists get disturbed over odd things). It shows labor productivity and real hourly compensation from 1947 to 2010.

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The disturbing part is that the two lines are different. Not the same. Distinct.

In fact, starting around 1970, the real hourly compensation line increases at a slower rate than productivity, until by 2010 the two differ considerably.

This might not seem like a big deal. Why get disturbed by two lines?

The trouble is that standard labor economic theory says that these two lines should be the same. Workers are supposed to be paid, on average, their marginal product of labor. It says so in all the textbooks. I’ve taught it in economics courses.

If productivity increases, then wages should increase by the same amount. That’s how standards of living improve. Productivity increases, wages increase to match, and people’s lives improve. That how it’s supposed to work.

This graph says this isn’t happening, and not just for one or two years. Productivity and wages have been diverging for decades in the U.S. Workers have been growing more and more productive, yet haven’t been rewarded for that.

So who’s benefited from this increased productivity?

Have consumers benefited through lower prices? Possibly some. But productivity increases only get passed on to consumers if competition forces firms to lower prices. That doesn’t seem to be happening.

Instead, corporate profits have been reaching record levels. On the one hand, that’s a good thing. Profits are good, and increased profits mean increased stock prices. Anyone who own stock benefits from that.

The problem is that the stock owners are benefiting at the expense of the workers. After all, it’s the workers who are causing that increased productivity (possibly through more or improved capital, but still). By all rights, they should be compensated for it. Why aren’t they?

That’s a good question, and it’s hard to come to any firm conclusions based on one report. However, the only explanation that comes to mind is that workers simply haven’t had the leverage and clout to demand that management pay them for their increased productivity. Union membership has declined pretty steadily during the same period that productivity and wages have diverged.

If workers organize and demand increased compensation, firms simply shut the U.S. factories down and move overseas, where wages are lower. Productivity is, too, but there’s often still a net benefit to the firms.

That’s great for firms and shareholders. It’s just not that great – nor fair – to the workers.

Decreasing labor clout. It seems to have made all the difference.

*”The compensation-productivity gap: a visual essay”, Fleck, Glaser, and Sprague, Monthly Labor Review, January 2011

The Mis-Named Cliff

“Fiscal Cliff” is a bad name. It’s one of those terms that the media love, because it sounds dramatic and terrifying. People stay tuned when they hear terms like “Fiscal Cliff”.

That’s not to say that the Fiscal Cliff isn’t serious or important. It is. But it’s not a cliff.

A “cliff” is something sharp and jagged and high, something that, should one fall off it, one plummets hundreds of  feet to one’s inevitable death. (“Fiscal” just means having to do with finances. I’m okay with that part.)

When pundits and politicians speak of “going over the Fiscal Cliff”, they mean essentially passing the milestone of midnight on December 31, 2012, the implication being that as of 12:01 on January 1, 2013, the U.S. economy will immediately be in free fall, plunging precipitously toward our collective death.

The reality is less dramatic and less headline-grabbing. If Congress and the President fail to resolve the current political impasse, on January 1, 2013, there will be substantial spending cuts to many federal programs, and tax rates will increase significantly for most Americans.

How much of an immediate impact this would have depends mostly on how long it lasts, and on how consumers and firms react to it. If the impasse lasts just a day or three, or even a week, into 2013, the direct impact would be relatively small. Even a spending cut of 10 percent and a tax increase of 20 percent would only represent a small sliver of GDP, if it only lasted for one-fiftieth of the year.

What’s more substantial are the indirect, psychological effects, particularly from news anchors throwing around ominous-sound words like “cliff”. Firms already are balking at future investment spending, and consumers who are already edgy about their future prospects are going to be very leery about spending money over the holidays if the impasse remains unresolved. Uncertainty is rarely a good thing for an economy.

One thing we don’t need is fear-mongering and over-dramatization. The current political standoff about federal spending and taxation is many things, but a “cliff” is not one of them.

Let’s call it for what it is: A Fiscal Impasse. No one’s falling off of anything on January 1.

… And Does Happiness Lead to Wealth?

Poverty may beget poverty. And happiness, happiness. According to the Los Angeles Times:

People who express more positive emotions as teenagers and greater life satisfaction as young adults tend to have higher incomes by the time they’re 29, according to a study published Monday by the Proceedings of the National Academy of Sciences.

The study asked teenagers about their life satisfaction, and later looked at their incomes at age 29. The happiest teenagers  were making an average of $8,000 more than the gloomiest by that time. According to the article, “Deeply unhappy teens’ future incomes were 30% lower than the average, while very happy teens earned 10% above average.”

 

Are the Poor More Irrational, or Does Poverty Lead to Poverty?

Why are the people who can least afford to buy lottery tickets the most likely to do so? Any half-decent mathematician can show that lottery tickets are a losing bet. Buying them is irrational to buy them, unless you derive pleasure from losing. The same goes for taking out high-interest paycheck loans.

Are the poor just more irrational than others? Are they poor because they not financially savvy? Or perhaps is something about being poor that’s at the root of the problem?

A recent behavioral economics study suggests that it may be the latter.

Researchers from University of Chicago, Harvard, and Princeton set up five different economic games. In one, for example, 60 participants played an “Angry Birds” type slingshot game. “Poor” players were allowed 3 shots per round, while the “rich” got 15.

The poor players were more careful with their shots and earned more points per shot than the rich. Interpretation: When you have less money, you’re more careful in spending it, and that pays off.

That is, unless they were allowed to “borrow”. Players were given the option of taking 1 extra shot, but in exchange had to give up 2 shots in a later round. This obviously was a bad deal – an effective 100% interest rate – but the poor players were 12 times as likely as rich players to do so. Never mind that the poor could least afford to sacrifice any of their 3 shots. And “borrowing” a shot eliminated any advantage the poor got from their added care in shooting.

Admittedly, Angry Birds games are a long way from the real world, but economic experiments such as these can go a long way towards shedding light on actual human behavior, particularly when a number of different games find evidence supporting the same conclusions.

The researchers concluded that people living in poverty aren’t necessarily less rational. They just see things differently, perhaps focusing more closely on certain specific needs, and disregarding others. When messages are tailored to the way poorer people are thinking, they do better at reaching goals.

There are lots of ways that society can help the poor improve their financial (and health) situations. Things like automatically enrolling low-wage employees in retirement and savings program, or mandatory school vaccination policies.

It’s easy to brush off the problems of the poor and simply blame the poor themselves. But studies such as this suggest that poverty itself might be one of the causes of poverty. This might help to explain why it’s so difficult for societies to alleviate it.