In this video we will discuss the national debt and its implications for an economy.
The national debt, or public sector debt, is the total debt of the government accumulated
over time.
It will typically rise when there is a budget deficit and fall when there is a budget surplus.
A budget surplus or deficit occur annually as tax revenues either exceed or fall below
government spending for that specific fiscal year.
The national debt is not the same as the budget deficit.
It’s very important that you remember this and do not confuse the two concepts.
To help clarify, let’s look at some numbers.
Here’s some made up data to help improve your understanding.
The assumptions are that as of 2015, the government had no national debt and plans on paying down
the debt in the years it runs a surplus.
In fiscal year 2015, this hypothetical government collected $500 billion in tax revenue and
spent $700 billion.
This resulted in a difference of -$200 billion.
The result is a budget deficit of $200 billion and our national debt has now increased to
$200 billion.
This is because the government must borrow to finance a budget deficit.
When they overspend, it will be funded through borrowing.
In 2016, they collected $600 billion in tax revenue and spent $650 billion.
This year they ran a smaller budget deficit of $50 billion, which is then added on to
the existing national debt of $200 billion.
At the end of 2016 the national debt would be $250 billion.
In 2017 government tax revenues and spending were equal, so we say they balanced the budget
this year.
This results in no change to the national debt.
In 2018, government spending exceeds tax revenues collected by $300 billion and another $300
billion is added to the national debt bringing the total national debt to $550 billion.
In 2019, expenditure exceeds tax revenues by $500 billion, increasing the national debt
to $1,050 or one trillion fifty billion dollars.
In 2020 the government collects more in tax than it spends which results in a surplus
of $100 billion.
Using this to pay down the debt reduces the national debt to $950 billion.
We’ve seen in this example that the national debt is rising, but in this case is it necessarily
a major concern for the government?
We have the value of national debt but its also important to know what the size of the
economy is.
National debt is often measured as a percentage of GDP.
Countries with increasingly large debt to GDP ratios should also be paying increasing
attention to their government policy.
In our previous example if the economy has a GDP of $1 trillion it should be quite concerned
about its growing levels of debt.
However, if the economy has a real GDP of $20 trillion, it may arguably be less of a
concern.
A rising national debt increases the debt burden of the country.
More resources will need to be dedicated to paying that money back as well as its associated
interest.
If a country has an unsustainable level of debt, it may have to default on some of its
debts which can have far-reaching economic implications.
If it defaults, it will lose a lot of credibility and find it much more difficult to borrow
in the future.
It will have to offer higher interest rates to borrow and may face challenging austerity
measures in order to address its underlying structural issues.
To tackle a large national debt, a country may have to adopt austerity measures, as has
been done in Greece.
Austerity involves government policies aimed at cutting back spending and increasing
tax collection in order to address its national debt issues.
VAT has been increased, public sector salaries were frozen and public sector assets were
sold to raise revenue.
If government borrowing in the loanable funds market causes a rise in interest rates, this
could reduce private sector borrowing.
This is called the ‘crowding out’ effect.
By now you should have a better understanding of the national debt and its implications
to an economy.
If you have any questions or comments, leave them below and let’s try and solve them
together.
That’s us done for now and I will see you in the next one.