Debt

Question 1

Cause of government dept

Answer 1

If the country is running a fiscal/budget deficit, or in other words they are spending more than they are bringing in through tax, then it is likely that they will finance this through borrowing and will result in growing dept.

The debt is the accumulation of the government deficit over time. It is the amount the government owes. The deficit (or surplus) is the difference between expenditure and revenue at any one point.

Question 2

How are fiscal deficits financed

Answer 2

Budget deficits are usually financed by borrowing, deficits can be rediced used austerity measures such as cutting government spending and increasing taxes such as VAT.

Question 3

Implications of high levels of public sector debt

Answer 3

Higher dept interest payments
Higher interest rates
Crowding out
Higher taxes in the future
Inflation
Confidence issues
Vulnerable to capital flight

Question 4

Implications of high levels of public sector debt - higher dept interest payments

Answer 4

As borrowing increased the government will have to pay more interest rate payments on those who hold bonds, this can lead to a greater percentage of tax revenue going to debt interest payments

Question 5

Implications of high levels of public sector debt - Higher interest rates

Answer 5

More borrowing in some circumstances push up interest rates because the markets are nervous about the governments ability to repay and therefore they demand high yields in return for that risk.

Higher interest rates will cause AD to fall and stunt economic growth.

Question 6

Implications of high levels of public sector debt - Crowding out

Answer 6

Rising public sector spending and debt drives down private sector spending and invesment.

When governments sell bonds in order to fund spending, the demand for money will increase, this therefore raises interest rates. At higher interest rates consumer spending and invesemtn will fall. AD falls.

Question 7

Implications of high levels of public sector debt - Higher taxes in the future

Answer 7

• If the dept to GDP rises rapidly the government may need to reduce dept levels in the future, it means future budgets wil need to either raise taxes or be forced to limit spending. Both of these can cause economic downturn and falls in gorwth.

Question 8

Implications of high levels of public sector debt - Vulnerable from capital flight

Answer 8

If a government finances its deficit by borrowing from abroad, then there is potential for the economy to suffer from capital flight in the future. For example, if investors feared a country like Greece would be forced out of the Euro and devalue, investors would lose out from the devaluation.

Question 9

Capital flight

Answer 9

When a large number of people in a country move capital and assets from one country to another. Usually in response to a political and/or economic crisis.

Demand for the domestic currency will likely fall, resulting in a depreciation. POSSIBLY resulting in inflation.

Question 10

Inflationary pressures

Answer 10

It is rare for government borrowing to cause inflation. But, some governments may be tempted to deal with high levels of debt by printing more money. This increase in the money supply can cause inflationary pressures to increase.

Question 11

Implications of high levels of public sector debt - EVALUATION

Answer 11

• It depends on the state of the economy, in a recession Keyens argued that borrowing can be beneficial in creating economic stimulus and shortening the recession or promoting growth. A growing deficit when this is not needed will be more damaging.
• It depends on levels of domestic saving. In 2016, Japan has a national debt over 225% of GDP, but bond yields are low because there is strong domestic demand for buying government borrowing.
• It depends on levels of government debt. If bond yields are low and borrowing relatively low, a government can finance debt by a relatively small share of tax revenues. This debt is manageable.
  HOWEVER
  However, if debt increases beyond a certain level and a growing share of GDP needs to go on debt repayments, debt can start to take tax revenue that is needed for public sector investment.

Question 12

Difference between a cyclical deficit and a structural deficit

Answer 12

• A cyclical deficit means that the size of the fiscal deficit is influenced by the state of the economy, in a boom, tax receipts are relatively high and spending on unemploment benefits is low.
• A structural deficit means that the deficit is not related to the state of the economy, when it recovers the deficit will not correct itself, for example this could be due to the long term affects of a ageing population or perhaps the undelrying level of personal and corporate tax avoidance.