Government Debt and Deficit

In some of our examples so far, we have assumed that the government runs a deficit in order to stimulate expanded aggregate demand and increased equilibrium production. In such a case, government spending is financed (at least partly) by borrowing. However, many people regard the government debt and government deficits as problems in themselves. This requires some comment, before we end the chapter.

Of course, the increased government debt will not be repaid in the foreseeable future. Instead, when government bonds mature, they will be "refunded" by selling new bonds to get money to repay them. But this should not be a surprise! Many large corporations operate in just the same way, raising capital by issuing bonds with the intention, not of repaying the bonds in any foreseeable future, but of refunding them. The corporations can do this because they have a perpetual source of income from which to pay interest, so far as anyone can foresee. And the government can do the same thing for the same reason: it has a perpetual source of tax revenues from which to pay interest.

However, interest payment -- so-called debt service -- is a burden.

Taxes must be collected to pay the interest on the debt, and there is no such thing as a good tax (especially from the point of view of the person who pays it!)
On the average, those to whom the interest is paid are richer than the taxpayers who pay it, so that a large government debt (at best) has something of a reverse Robin Hood effect.
If the debt and the debt service increase more rapidly than production itself, the increase is clearly not sustainable, and will eventually be stopped by a crisis if not by deliberate restraint of government deficits.
Many economists would worry that government borrowing would crowd out private borrowing for investment, so that people would be worse off in the future.

The last of these is most relevant to "the burden of the debt." In this vision, the "burden of the debt on future generations" is not that the future generations will have to pay off the debt, but that they will have less capital goods to work with and so be less productive. Some economists have gone so far as to argue that the taxes necessary to pay interest on a dollar of debt in perpetuity are just as much of a burden on citizens as a dollar of taxes now would be. This idea -- originally suggested by David Ricardo -- is called "Ricardian Equivalence" of taxation and borrowing.

That may not be the worst of it. If taxes create inefficiency and waste (and they almost always do), then there is an extra cost in raising taxes to pay interest on the debt. In such a case, revenue faces limits and debt service has to compete with other, perhaps more urgent human needs for the budget dollars.

So there are good reasons to be concerned about deficits and government debt. Most of them are beyond the limits of the Simple Keynesian Model, and some are more microeconomic, or even philosophical, than macroeconomic. But we will return to the issue in later chapters, armed with more complex and somewhat more realistic models, and take many of them into account.

Since there are good reasons to be concerned about government deficits and debt, we might wonder why large deficits and expanding government debt have been so common, especially in the recent decades in which "conservative" governments have been in power in most developed countries. Perhaps the Simple Keynesian model has the answer to that question: perhaps the deficits really do stimulate production, and that is a temptation even conservative governments find it difficult to resist!

Automatic Stabilizers