Mankiw: Macroeconomics



Mankiw: Macroeconomics

Main Points of Chapter 15

1. This chapter deals with issues surrounding government debt and deficits. The government debt is the total amount of money the government owes at a given point in time. The deficit is the amount of net new borrowing over a given time period. The debt is like the balance on a credit card account, and the deficit is like the dollar value of new charges less the amount repaid. If the government is running a deficit, its debt will be increasing.

2. The net U.S. national debt is quite a bit less than the gross debt (which is over $5 trillion), because about $2 trillion in debt is held by government agencies and trust funds (in effect, money the government owes to itself) and another $0.5 trillion is held by Federal Reserve Banks.

3. Right now the U.S. national debt is not large relative to GDP when compared to other nations or to U.S. history.

4. The outlook for the US debt over the next 30-40 years is not good, because a relatively larger percentage of the U.S. population will be elderly. The U.S. outlook, while bleak, is quite a bit better than that of Germany or Japan.

5. There are several problems with the way the government debt is normally measured. First, it does not adjust for inflation. If the nominal debt is rising over time at the inflation rate, the real debt is unchanged.

Second, it does not account for government assets. If a rise in debt is matched by a rise in government assets, there is no effect on the "net worth" of the government.

Third, it does not include likely future pension and Social Security liabilities, which may be substantial (see #4 above).

Fourth, it does not recognize that debt and deficits will tend to fall during expansions and rise during recessions.

6. The traditional view of government debt is that government deficits and increasing debt have the following long-run effects on the economy:

- Reduces national saving

- Increases the real interest rate

- Reduces investment

- Lowers k* and y* in the long-run, which reduces steady-state equilibrium consumption per person

- Increases the trade deficit (lowers net exports)

- Causes the real exchange rate to appreciate

7. In the short-run, a higher deficit will shift IS and AD right. Y and r will rise, with P unchanged.Eventually, P rises and the LM shifts left so that Y returns to LRAS, and r rises even more.

8. The Ricardian view of government debt is that consumers are rational and forward looking. To the extent that a higher government deficit today creates expectations of higher future taxes, consumers will spend less and save more today. If consumers face no borrowing constraints and look very far into the future, the increased consumer saving will completely offset the lower government saving. There will be no effect on saving, interest rates, investment, k*, y*, NX, ε, Y, r, P, AD, IS, or LM.

9. The Ricardian view does not hold if consumers are myopic (don't care about the future) or if they face borrowing constraints.

10. Economists still disagree about whether the traditional view or the Ricardian view is correct. In any case, the Ricardian view suggests strongly that deficits may not matter as much as the traditional view implies.

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