Fundamental Principles of National Debt as an Element of Budgeting

Introduction 

The public debt or national debt can simply be defined as the amount of money that the country owes to the lenders of itself (Hubbard, 2012). In most instances, these include businesses, individual or even other governments. It is also the accumulation of the annual budget deficit. Public debt often represents the state obligation towards their creditors that are primarily based on contracts. On the other hand, the repayment of the public debt is evidently obligatory of the state budget. According to Wagner (2005, p. 4), public or government debt comprises of the entire amount that the government borrows within the aim of financing the budgetary position for instance post war period experienced higher controversy on the burden of the government expenditure financed by the public debt. Public debt is also considered as the key source of the extraordinary state revenue that is evident in various parts of the developed economies and even in some developing economies (Wagner, 2005, p. 4). 

The US Structure of Public Debt 

Apparently the US government has constantly had a fluctuating public debt since 1789 except in the years between 1835 and 1836. The US public debt as a percentage of the country's GDP hit the peak level at the time of Harry Truman's presidential period and throughout the period before and after the WWII. Public debt as GDP’s percentage consequently dropped rapidly in the post-WWII period, reaching a lower level around 1974 during the reign of Richard Nixon (Romer & Romer, 2007, p. 9). According to Sarno (2001, p. 119) asserts that there is a nonlinear reversion in the US debt-GDP ratio since 1916. Further, debt as the GDP share has been increasing consistently since that time save for the eras of President Bill Clinton and Jimmy Carter (Romer & Romer, 2007, p. 6). Furthermore, the public debt increased in the 1980s as Ronald Reagan decided to cut tax rates further and at the same time increase the military expenditure. It, however, declined around 1990s, as a result of reduced military spending, increasing taxes and 1990 boom. Additionally, the public debt rose rapidly between 2007–2008 financial crises and the tax revenues declined while spending increased. 

The US Treasury Department often manages the US national debt via the Bureau of the Public debt. Higher interest rates have led to expanding government debt which apparently has been reported to have led to the reduction of investment and reduction of asset’s value (Hubbard, 2012, p. 206). In a general view, the public debts include the bonds, Treasury bill and even notes that are bought by larger investors. On January 26, 2016, the public debt was reportedly 75% of the last twelve months of GDP. Intra-governmental holdings had stood at approximately $5.34 trillion, which gave a sum gross national debt of around $18.96 trillion ( www.cbo.gov , 2018). On September 8, 2017, it was reported that the US debt had surpassed %$20 billion. This made the debt-to-ration to rise to about 104%. That was primarily founded on most current second quarter GDP of approximately $ 19.2 trillion. However, the national debt about $14.6 trillion making the public debt-to-GDP rations significantly a safe of around 76%. Based on a report by World Bank, the tipping point was approximately 77 Percent ( www.cbo.gov , 2018). 

The budget deficit in fiscal 2018 is forecast to be $804 billion, an increase of $139 billion (21%) from the $665 billion in 2017 and up to $242 billion (39%) over the previous baseline forecast (June 2017) of $580 billion for 2018 ( www.cbo.gov , 2018). The June 2017 forecast was essentially the budget trajectory inherited from President Obama; it was prepared prior to the Tax Act and other spending increases under President Trump. For the 2018-2027 periods, CBO projects the sum of the annual deficits to be $11.7 trillion, an increase of $1.6 trillion (16%) over the previous baseline (June 2017) forecast of $10.1 trillion ( www.cbo.gov , 2018). The $1.6 trillion debt increase includes three main elements: 1) $1.7 trillion less in revenues due to the tax cuts; 2) $1.0 trillion more in spending, and 3) Partially offsetting incremental revenue of $1.1 trillion due to higher economic growth than previously forecast. According to www.cbo.gov (2018), debt held by public is expected to rise from 78% of GDP in 2018 to 96% by 2028. That would be the highest level since the end of World War Two. 

Macroeconomic Theories of National Dept 

Inflation often lower real value of the nominal debt which forms the basis for the government to reduce it. Majority of the British classical economists have argued that public debt is ruinous for the economy (Holtfrerich, 2014, p. 63). Arguably, the classical perspective of the public debt is believed to be highly pessimistic including Smith, Hume, Say, Ricardo, Postlethwayt, Jefferson, Mill, and Marx. They all believe that state borrowing is arguably wasteful, disastrous to prosperity, and morally unjust. Public debt optimists such as De Pinto, Mortimer, Malthus, and Dietzel are arguably a minority during this era but significantly influence subsequent Keynesian theory (Tsoulfidis, 2007, p. 2). 

The main classical economists Smith, Ricardo and J.S. Mill clearly shared a universal set of philosophy including the notion that the government expenditure satisfies useful social functions that cannot be performed by the private sector (Tsoulfidis, 2007, p. 2). The perspectives of Smith and Ricardo regarding the public debt on country’s development posits that financial government expenditure through the tax would lead to results that are dissimilar from those of financing through public bonds (cbpp.org, 2018). Smith in his book Wealth of Nations apparently focuses on the economic impacts of the public debt. Smith asserts that it would not be suitable for the government to run budget deficits since buildup of debt is “destructive” for a country. 

Arguably, Smith went ahead to criticize the mercantilist notions in relation to which interest’s payment on the public debt is similar to “the right hand which pays the left” (Tsoulfidis, 2007, P. 3). This is the case because he believed that the need to redeem the debt would eventually lead into augmented taxation ultimately resulting into flights of domestic capital in addition to the currency depreciation with unenthusiastic impacts on enduring domestic producers. According to Smith, the debt would severely retard the normal development of the country towards prosperity and riches. 

Ricardo believes that financing of the public expenditure through borrowing is greatly injurious to the entire economy and to the nations’ wealth-producing capacity (Hubbard, 2012, p. 212). Apparently borrowing greatly diminishes the savings which include income ready to be invested prolifically. Based on the fact that government expenditure is not productive in terms of paying a public employee, engagement of wars and even maintenance of the army, it would follow that public debt would substantially undermine the capacity of the economy to accumulate. Continuous dependence on public debt clearly builds up the level of the public debt stock which then diverts to debt servicing at the expense of economic growth and domestic consumption, however, as posited by Ricardo, pubic debt does not affect the interest rates (Hubbard, 2012, p. 2013). 

Long-Term Effect of Public Debt 

Contemporary economies have observed that budget deficit and the public debt are key instruments of the anti-cyclical policies. However, a majority of the economists have believed that budget deficit together with public debt is negative phenomenon besides being a major threat to the entire economic system since it causes a crisis (Braga & Vincelette, 2010, p. 63). In the short run, economists have argued that the public debt is one of the good ways for the government to get additional funds in their economic growth. It is evident that the public debt is one of the safest ways for the foreigners to invest in the nation’s development through purchasing the government bonds. It is considered to be safer compared to the foreign direct investment. When effectively employed, public debt can significantly improve overall living standards in the country. Such is the case since it often enables the state to construct infrastructures like roads, improve education and even offer the pension (cbpp.org, 2018). 

According to Tsoulfidis (2007, p. 3) classical economists have continued holding onto the opinion that public debt and budget deficit are not to be welcomed in an economy but would be suitable in the short term to partially cover some of the outstanding short-term demands for the public spending. Long-term indebtedness of a country has been justified only in instances where the uses of the loan funds are directed into productive purposes. Within the short-term period, it would include capital investments whose rates of return is significantly much higher compared to the interest rates on the taken loan. Private and public indebtedness is primarily directed towards ultimate harmonization of the times streams of income and expenditure. 

According to Braga & Vincelette (2010, p. 63) in the long-term, public debt has been shown to be detrimental to the country’s economy. The government in most cases tends to take a huge portion of debt since the payback always makes them admired by the voters. This investor often measures the risk level through making the comparison of the debt to the state’s entire economic output referred to as the GDP. Reinhart & Rogoff, (2013, p.3) asserts that when the debt strategies are a decisive level, investors often start to insist on elevated interest rate. With higher interest rates, it turns to be costly for the government to refinance its current debt, therefore, a huge portion of the incomes will go into debt repayment and less towards funding government services a scenario referred to as sovereign debt crisis 

In the long run, the public debt might become very large ultimately propelling with emergency brakes on. The investors, on the other hand, propel interest rates in return for a higher risk of defaults which ultimately makes certain aspects of economic growth like auto loans, housing and even commercial development costly. In to address such burden there is the need for the government to be more cautious to find particular sweet spots of the public debt. It ought to be large enough to propel the economic development but at the same time small enough to keep the interest rates lower (Tsoulfidis, 2007, p. 4). The growth of debt share to GDP clearly represents an indicator of the fiscal disorder that demands suitable intervention. 

Causes of Debt Crisis 

A debt crisis is a situation where the country owes more than it can pay off in loans. In such a situation the state is not able to pay the interests on its debt. For instance, the EU debt crisis was argued to be unusual and was primarily caused by the lower-income countries such as Italy and Greece enjoying benefits of low-cost debt as a result of their inclusion in higher-income EU. According to Braga & Vincelette (2010, p. 63) a sovereign debt crisis is often caused when a state racks up heavy debts to pay for a war. In the situation where the country prints more money to pay off their debt, they would create the worst predicament of hyperinflation. The sovereign debt crisis can further be caused by recessions, however, the developed countries do not necessarily resort to some of standard toolkit of the developing nations such as debt structuring and higher inflation (Reinhart & Rogoff, 2013, p. 2). 

For instance the year 2008 financial crisis was argued to be the major reason for the crisis in Spain. Despite being responsible fiscally, Spain’s banks were believed to have invested heavily in the real estate ( Pettinger, 2015, n.p). Thus, when the bubble burst, the government took over the bank’s debt. Furthermore, the recession also as believed to have caused Iceland’s debt crisis. Most of the Iceland banks had significantly invested overseas. Thus when the regime nationalized all financial intuitions and printed huge sum of money to settle all their debts, the value of the country’s currency declined by more than 50 percent within a period of one week. Furthermore, in the Mexican crisis between 1994 and 95, the government’s fear of default resulted into inability to issue new debts thus confirming the fears of default (Cole & Kehoe, 2000, P. 91). 

On the other hand, the US debt crisis was argued by the economists to be self-inflicted. Unlike was the case in Greece and other nations that had experienced debt crisis, the interest rates on the treasuries in the US were not rising and more precisely, they were at 200-years low. The debt crisis was, therefore, caused by the Congress’ refusal to raise the debt ceiling of the country in the year 2011. They strongly believed that this was the only to force reduced spending and even reduce the lower national debt. Additionally, their refusal is believed to have almost made the US default on its debt. Therefore, they had to raise the ceiling but this was only after installing the mandatory spending cut which was termed as sequestration. Therefore the Congress was reported to have narrowly avoided falling off the fiscal cliff (Braga & Vincelette, 2010, p. 129). 

Why Can Some Countries Have Higher Debt/GDP Ratios than Others 

Some countries‘debt such as Japan is proportionally larger than others, for instance, Greece but this does not cause debt crisis because of several factors. One of the explanations for this is that Greece does not always hold their debt domestically in the currency under their control (Turner, 2016). A large portion of their debt is owed to the foreign lenders and Euro is not a currency which is under the absolute control of Greece. On the other hand, Japan debts are majorly owed domestically while their currency is also under Japan's sole control. Consequently, Japan might be as well in a significant debt crisis that is believed to be unrecognizable and this is primarily as a result of the concentration of debt in Japan’s frontiers. According to Turner (2016), Japan also manages its high debt ratio to prevent debt crisis using monetary policies to kick start the economy for instance through borrowing and then pumping the money back into the economy which generates more growth. Also, Japan in most cases ensures that they get low interest rates that would not eventually results to debt crisis in the long run. Therefore, Japan has a higher debt ratio but at the same time have been able to manage possible debt crisis unlike is the case with Greece which has lower debt ratio. 

Conclusion 

In conclusion, the paper has critically discussed the national debt commonly referred to as public debt and the current public debt of the US. The paper has further discussed the macroeconomic theories that focus on public debt and all seem to agree on the negative consequences of public debt in the long run. The public debt might be imperative in short term but it is highly disastrous in the long-term position of the economy. Numerous countries including the US have at one time experienced debt crisis caused by numerous factors as discussed above. Therefore, when the government plans to finance its budget with public debt, it would be imperative to weigh both the positive and negatives that might emerge in the shorter and in the long-term. 

References 

Braga, C. A. P., & Vincelette, G. A. (Eds.). (2010). Sovereign debt and the financial crisis: will this time be different? . World Bank Publications. 

cbpp.org (2018). Policy Basics: Deficits, Debt, and Interest. (2018). Retrieved from https://www.cbpp.org/research/federal-budget/policy-basics-deficits-debt-and- interest 

Cole, H. L., & Kehoe, T. J. (2000). Self-fulfilling debt crises. The Review of Economic Studies , 67 (1), 91-116. 

Hubbard, G., (2012). Consequences of Government Deficits and Debt. International Journal of Central Banking. (2018). Retrieved from http://www.ijcb.org/journal/ijcb12q0a11.htm 

Holtfrerich, C. L. (2014). Public Debt in Post ‐ 1850 German Economic Thought vis ‐ à ‐ vis the Pre ‐ 1850 British Classical School. German Economic Review , 15 (1), 62-83. 

Pettinger, T., (2015). Spanish Economic Crisis Summary. Retrieved from 

https://www.economicshelp.org/blog/5525/economics/spanish-economic-crisis- summary/ 

Reinhart, M. C., & Rogoff, M. K. (2013). Financial and sovereign debt crises: Some lessons learned and those forgotten (No. 13-266). International Monetary Fund 

Romer, C. D., & Romer, D. H. (2007). Do tax cuts starve the beast: The effect of tax changes on government spending (No. w13548). National Bureau of Economic Research. 

Sarno, L. (2001). The behavior of US public debt: a nonlinear perspective. Economics Letters , 74 (1), 119-125. 

Tsoulfidis, L. (2007). Classical economists and public debt. International Review of Economics , 54 (1), 1. 

Turner , p. A., (2016). A Tale of Two Debt Write-Downs . Retrieved from 

https://www.project-syndicate.org/commentary/greece-japan-debt-relief-by-adair- turner-2016-06?barrier=accesspaylog 

Wagner, R. E. (2005). Debt, money, and public finance. In Handbook of Public Finance (pp.195-215). Springer, Boston, MA. 

www.cbo.gov (2018). CBO Budget and Economic Outlook 2018-2028-April 9, 2018 . Retrieved from: https://www.cbo.gov/publication/53651