Order Code RL30583
CRS Report for Congress
Received through the CRS Web
The Economics of the
Federal Budget Surplus
Updated March 30, 2001
Brian W. Cashell
Specialist in Quantitative Economics
Government and Finance Division
Congressional Research Service ˜ The Library of Congress
The Economics of the Federal Budget Surplus
Summary
Fiscal 1998 marked the first year that total receipts exceeded outlays in the
federal budget since 1969. Since then, the budget has been in surplus and official
projections expect the budget to remain in surplus for the foreseeable future.
Congressional Budget Office (CBO) baseline projections indicate that the budget
surpluses are expected to grow steadily over the next 10 years.
Over fairly short periods of time, say three or four years, fiscal policy can affect
the rate of economic growth by adding to, or subtracting from, aggregate demand.
For a time, the effect on the economy may even be larger than the initial change in the
budget. These effects, however, tend eventually to diminish because of either higher
interest rates or rising prices. Estimates of the multiplier effect on the economy of a
change in fiscal policy vary, but most of them suggest that it reaches a peak
somewhere between one and one-and-a-half times size of the change in the budget.
In most economic models, that peak effect is realized within one or two years of the
initial change in policy.
One measure economists use to assess fiscal policy is the structural, or
standardized-employment, budget. This measure estimates, at a given time, what
outlays, receipts and the surplus would be if the economy were at full employment.
Although the actual budget has been in surplus since 1998, the standardized measure
first registered a balanced budget in 1999. Between 1992 and 2000, the actual budget
surplus increased from -4.7% to 2.4% of gross domestic product (GDP), a shift of 7.1
percentage points. Over the same period the standardized measure rose from -2.9%
to 1.1% of GDP. That suggests that a little more than half of the shift was the result
of changes in policy, and a little less than half was attributable to the economic
expansion.
In the long run, economic growth is determined primarily by three factors;
growth in the labor force, the rate of technological advance, and the amount of capital
available to the workforce. Of the three, the last one may be the most susceptible to
the influence of policymakers. The larger the capital stock is, the more productive the
labor force tends to be. While it is possible for fiscal policy to have an effect on the
rate of technological progress in the way public money is spent, it probably has a
much larger effect on growth through its influence on the size of the domestic stock
of capital and the amount of capital available for each worker in the labor force.
In 1996, the public sector contribution to national saving was small. By 2000,
public sector saving had risen to 5.3% of GDP. Over the same period, private sector
saving fell from 16.5% of GDP to 13.0%. Net inflows of foreign capital rose from
1.4% to 4.3% of GDP. Total funds available for investment in the U.S. from all
sources rose from 18.7% to 22.6% of GDP.
Contents
A Brief History of the Budget Surplus . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Deficit or Surplus, What Difference Does it Make? . . . . . . . . . . . . . . . . . . 3
Fiscal policy in the short run . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Fiscal policy in the long run . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Reducing the Federal Debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
List of Figures
Figure 1. Outlays, Receipts, and the Surplus, 1970 - 2000 . . . . . . . . . . . . . . . . . 2
Figure 2. Actual and Standardized Budget Surplus . . . . . . . . . . . . . . . . . . . . . . 6
Figure 3. U.S. Saving by Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Figure 4. Federal Debt Held by the Public as a Percentage of GDP . . . . . . . . . 11
The Economics of the Federal Budget
Surplus
Fiscal 1998 marked the first year that total receipts exceeded outlays in the
federal budget since 1969. Since then, the budget has been in surplus and official
projections expect the budget to remain in surplus for the foreseeable future.
Congressional Budget Office (CBO) baseline projections indicate that the budget
surpluses are expected to grow steadily over the next 10 years.1
When the budget was in deficit, deficit reduction was an important objective in
the setting of overall budget policy. Over the past few years, a combination of budget
policy and a booming economy entirely eliminated the deficit. Now that the budget
is in surplus, there is debate as to what should be done with the surplus. For example,
there are those who argue that the surplus should be “set aside” to protect Social
Security while others argue that taxes should be cut and the surplus returned to
taxpayers.
Strictly speaking, economics generally has little to say regarding whether or not
a budget surplus is a good thing or not. But, whether the budget is in deficit or
surplus, and whether the budget surplus is growing or shrinking, have consequences
for the performance of the economy, both in the short and long run. At the same
time, the performance of the economy can have substantial effects on the budget as
well.
A Brief History of the Budget Surplus
The share of income that is saved is simply a reflection of relative preferences for
current and future consumption. From an economic standpoint, there is no optimal
rate of saving. Nonetheless, raising the national rate of saving has long been a goal
of policymakers.
But most economists believe the capacity of public policy to influence private
saving behavior is limited. The one certain way to raise the national saving rate
through public policy is to increase the public sector saving rate, and that is just what
has happened. Because public saving rose while private saving fell, the national
saving rate has risen since 1995.
1 There is more than one projection, each one reflecting different assumptions about
discretionary spending. For a discussion of the uncertainty of budget projections, see:
Congressional Budget Office.
The Budget and Economic Outlook: Fiscal Years 2002-2011,
January 2001. pp. 93-103.
CRS-2
In recent history, budget
surpluses have been rare, and a succession of surpluses
rarer still.2 In every year between fiscal 1969 and 1998, the federal budget was in
deficit; that is, outlays exceeded receipts. Beginning in 1929 and up until 1969, the
budget was in surplus for a total of nine years, and during that time was never in
surplus for more than three years in a row. If nothing else, being now in the fourth
consecutive year of budget surpluses with the prospect for more is novel.
Figure 1 presents figures for federal budget outlays, receipts, and the surplus
beginning in 1970. Rather than showing dollar amounts, each of the three series is
expressed as a percentage of gross domestic product (GDP). Showing the figures in
this way focuses attention on the size of the budget aggregates relative to the
economy as a whole.
Figure 1. Outlays, Receipts, and the Surplus, 1970 - 2000
24
3
Outlays, left scale
Surplus, right scale
2
23
1
22
0
21
-1
20
-2
-3
19
percent of GDP
percent of GDP
-4
18
-5
17
Receipts, left scale
-6
16
-7
1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000
Source: Office of Management and Budget.
From a position of near budget balance in 1970, the budget surplus became
negative (a budget deficit). In part because of an economic contraction beginning in
late 1973 and ending in early 1975, the surplus fell to -4.2% (in other words, a deficit
equal to 4.2%) of GDP in 1976. Another economic downturn began in mid-1981 and
ended in late 1982 contributing to another drop in the surplus, to -6% of GDP in
2 Unless otherwise specified, in this report surpluses and deficits (negative surpluses) reflect
both on- and off-budget receipts and outlays. In other words, they are from the unified
budget.
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1983. Since then, with a brief reversal attributable to an economic contraction in
1990 and 1991, the surplus has increased steadily. In fiscal 2000, the surplus reached
2.4% of GDP. While the budget has clearly been influenced by changing economic
conditions there nevertheless appeared to be a tendency towards smaller and smaller
surpluses (at the time they were characterized as increasing deficits, which is the same
thing) between 1970 and 1983. Since then the trend appears to have reversed.
Deficit or Surplus, What Difference Does it Make?
The federal budget and the economy are closely interrelated. The strength or
weakness of the overall economy affects the levels of outlays and receipts
substantially. The budget also has significant effects on the economy, both in terms
of how fast the economy grows, and also in terms of the overall allocation of
resources.
Fiscal policy in the short run. Over fairly short periods of time, say three
or four years, fiscal policy can affect the rate of economic growth by adding to, or
subtracting from, aggregate demand. Consider, for example, a one-time increase in
total federal spending, with no matching rise in tax receipts. Each additional dollar
of government spending becomes income for those satisfying the initial increase in
demand for public goods and services. In turn, some of that increase in income will
be spent raising the income of those who satisfy the second wave of increased demand
for goods and services. Theoretically, this process continues with each successive
increment to income getting smaller and smaller as some is saved and some is spent.
Because of the initial increase in spending and the additional spending that is
subsequently stimulated, the economy grows somewhat faster than it otherwise would
have. For a time, the size of the economy may increase by more than the initial
increase in government spending. Government spending is thus said to have a
‘multiplier effect.’ There can also be a multiplier effect in the case of a spending cut,
although the effect is in the opposite direction. If the government reduces spending,
that cuts the incomes of those who otherwise would have provided goods and
services to the government. They then must either reduce their spending or their
saving. To the extent that they cut spending, it adds to the decline in output initiated
by the cut in public spending.
The government may also be able to influence the rate of economic growth in the
short run via tax cuts or increases. Just as an increase in public sector spending
temporarily increases some incomes, so does a tax cut increase the amount of income
taxpayers have at their disposal. Some of that increase in aftertax income is likely to
be spent and so tax cuts may have a multiplier effect just as changes in government
spending do. A tax increase reduces disposable income and so contributes to a
slowdown in private sector spending.
Limits on fiscal policy. That is not the end of the story, however. In
the view of most economists, the government cannot permanently increase the size
of the economy just by increasing spending, or cutting taxes. As is often the case in
economics, other things do not remain equal. An increase in spending, or a tax cut,
reduces the surplus and so cuts the public sector’s contribution to the overall supply
of credit. Reduced credit supply tends to raise interest rates. Higher interest rates,
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in turn, discourage borrowing in the rest of the economy for those activities that
depend on credit, especially housing and consumer durable goods.3
Higher interest rates also tend to make dollar-denominated financial assets more
attractive to overseas investors. In order to buy those assets, however, foreigners
must first buy dollars. This increased demand for dollars pushes up the foreign
exchange value of the dollar. The ‘stronger’ dollar makes imported goods cheaper,
and makes goods and services produced in the U.S. more expensive abroad. The
change in prices tends to increase demand for U.S. imports and reduce demand
abroad for U.S. exports, raising the trade, or current account, deficit. Thus, some of
the stimulus is, in a sense, exported.
An increase in aggregate demand, stimulated by an increase in spending or a cut
in taxes, can be satisfied in one of two ways; either an increase in real production, or
an increase in the general price level.4 If the economy is already operating at full
employment, and the capital stock is operating at or near full capacity, then it is more
likely that any increase in demand will be met by higher prices than by increased
production of goods and services. Given a fully employed economy, an increase in
government spending would yield a much larger increase in nominal than it would in
real GDP.
In a slack economy, with high unemployment and idle resources, a stimulative
fiscal policy would be less likely, at least initially, to push up prices. Instead, any
increase in demand could be met by increased employment and capacity utilization
rates. In an economy with excess capacity, a stimulative fiscal policy would tend to
increase the production of goods and services more than it would prices, and any
increases in real and nominal GDP would tend to be of similar size.
Given a sufficient fiscal policy boost, the economy would tend gradually to
converge to full employment. As the economy approaches full employment of both
labor and capital, additional increases in aggregate demand would be more likely to
be satisfied by higher prices than by increased real output.
Whether because of higher interest rates or rising prices, any effects of an
increase in government spending, or a tax cut, on the rate of economic growth tend
to diminish over time. Estimates of the multiplier effect of a change in fiscal policy
vary, but most of them suggest that it reaches a peak somewhere between one and
one-and-a-half. In most economic models, that peak effect is realized within one or
two years of the initial change in policy. In other words, for every dollar increase in
federal spending, the economy, within a year or two, will be larger than it otherwise
would have been by somewhere between a dollar and a dollar-and-a-half.5
3 When the budget is in deficit, there is an increase in the public sector’s demand for credit
which has similar consequences for interest rates.
4 In the short run, to which this discussion is limited, supply is more or less fixed.
5 See: U.S. Library of Congress, Congressional Research Service,
How Big Is The Fiscal
Policy Multiplier? Report 94-403 E, by Brian W. Cashell.
CRS-5
Not all changes in spending and taxes, however, reflect changes in fiscal policy.
Just as the budget can have an effect on short-run economic growth, so does the rate
of economic growth have an effect on the budget. Faster economic growth tends to
raise revenues above, and reduce outlays below, what they otherwise would have
been. Faster growth means more people are working which raises taxable incomes,
which in concert with progressive tax rates increases tax receipts. Faster economic
growth, along with higher incomes and employment, tends to reduce outlays,
especially for spending on unemployment insurance and various income support
programs.
What this means is that it may be difficult to examine the ups and downs in the
budget, and in the surplus in particular, and discern whether those changes reflect the
fluctuations of the economy or are due to deliberate changes in budget policy.
The standardized budget. One measure economists use to assess fiscal
policy is the structural, or standardized-employment, budget. This measure estimates,
at a given time, what outlays, receipts and the surplus would be if the economy were
at full employment.6 It is a way of separating changes in the budget totals that are due
to changes in overall economic conditions from those changes that are the result of
deliberate changes in tax and spending policy. Changes in the standardized-
employment surplus reflect changes in policy and are not influenced by changes in
underlying economic conditions. For example, if the economy is less than fully
employed, then the standardized measure of outlays is less than actual outlays,
standardized receipts are higher than actual receipts, and the standardized surplus is
larger than the actual surplus.
To assess if fiscal policy is stimulative or contractionary, economists track the
standardized-employment surplus as a percentage of potential GDP. As the economy
grows, outlays and receipts tend to rise as well. Comparing the budget to GDP filters
out changes that are due to variations in the overall size of the economy. Potential
GDP is an estimate of what the total value of production of goods and services would
be if labor and capital resources were fully employed. Using potential GDP as a base
for comparison avoids the problem of cyclical factors masking changes in fiscal
policy. An increase in the standardized budget surplus relative to potential GDP
would be considered indicative of a contractionary fiscal policy. Similarly, a decline
in standardized budget surplus as a percentage of potential GDP would be indicative
of a stimulative fiscal policy.
The Congressional Budget Office (CBO) regularly publishes estimates of the
standardized budget. Figure 2 compares the standardized budget surplus with the
actual surplus since 1960, both as a percentage of GDP. 7
6 For a definition of full employment see: U.S. Library of Congress, Congressional Research
Service.
Inflation and Unemployment: What is the Connection? Report RL30391, by Brian
W. Cashell.
7 It should be noted that these data incorporate other adjustments in addition to the one related
to the business cycle. These adjustments removed, for example, the effects of outlays for
deposit insurance, receipts from auctions of the electromagnetic spectrum, and foreign
(continued...)
CRS-6
Figure 2. Actual and Standardized Budget Surplus
3
Actual
1
Standardized
-1
-3
% of potential GDP
-5
-71970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000
Source: Congressional Budget Office.
For the most part, the two series exhibit the same behavior over time. But since
1970, the two have moved in opposite directions 4 times, indicating that either the
surplus rose at a time that fiscal policy was actually expansionary or that it fell at a
time when fiscal policy was actually contractionary. The most recent instance was in
1990 when a weakening economy and substantial outlays for deposit insurance helped
reduce the actual budget surplus but, when measured by the standardized budget,
fiscal policy was actually slightly contractionary.
Most of the time, the actual budget surplus has been smaller than the
standardized measure, suggesting that at least by CBO’s calculations the economy has
more often than not been less than fully employed. However, between 1965 and
1970, the actual surplus was higher than the standardized one, indicating a vigorous
economy with unemployment below its estimated long-run sustainable rate.
More recently, the actual surplus has again risen above the standardized measure.
Although the actual budget has been in surplus since 1998, the standardized measure
first registered a balanced budget in 1999. Between 1992 and 2000, the actual budget
surplus increased from -4.7% to 2.4% of GDP, a shift of 7.1 percentage points. Over
7 (...continued)
contributions related to Operation Desert Storm S all of which are considered to be one-time
events or otherwise unrelated to discretionary policy.
CRS-7
the same period the standardized measure rose from -2.9% to 1.1% of GDP. That
suggests that a little more than half of the shift was the result of changes in policy, and
a little less than half was attributable to improving economic conditions.
Since 1992, fiscal policy as measured by changes in the standardized budget
surplus, has been contractionary. In every year since 1992, the standardized surplus
has grown relative to GDP. Between 1992 and 2000, the average increase per year
in the surplus was 0.5% of GDP. The average annual rate of increase in real GDP
over the same period was 3.9%. Although fiscal policy was contractionary, other
factors contributing to economic growth more than compensated.
Fiscal policy in the long run. A constant deficit or surplus, by itself, is
believed to have little if any effect on the short run rate of economic growth. It is
changes in the surplus that matter for short run growth. However, whether the
budget is in surplus or not does have consequences for the
composition of economic
output, and that can have an effect on growth in the long run.
In the long run, economic growth is determined primarily by three factors;
growth in the labor force, the rate of technological advance, and the amount of capital
available to the workforce. Of the three, the last one may be the most susceptible to
the influence of policymakers. The larger the capital stock is, the more productive the
labor force tends to be.
While it is possible for fiscal policy to have an effect on the rate of technological
progress in the way public money is spent, it probably has a much larger effect on
growth through its influence on the size of the domestic stock of capital and the
amount of capital available to each worker in the labor force. How this comes about
can be illustrated by a brief introduction to economic accounting.
The total value of national output can be measured in two ways. Either the total
value of the goods and services produced can be added up, or the total value of the
incomes resulting from that production can be counted. These two accounts, at least
in the abstract, add up to the same total.
The measure of total output based on the value of production is typically
subdivided into several categories of demand. Specifically, it is calculated as the sum
of consumption spending (C), investment (I), government spending (G) and the
difference between exports (X) and imports (M):
GDP = C + I + G + (X - M).
CRS-8
The alternative measure of total output is based on the various uses to which
income is allocated. On this side of the economic accounting ledger the value of
national output is expressed as the sum of consumption (C), private sector saving
(S)8, and tax payments (T):
GDP = C + S + T.
Combining the two equations, and simplifying gives:
I = S + (T - G) + (M - X).
That is, total investment spending is equal to the sum of private saving (S), the
government budget surplus (T - G), and the difference between imports and exports
of goods and services (M - X). The last equation is an identity. In other words,
investment is
by definition equal to the sum of private saving, the budget surplus, and
net capital inflows from abroad. Other things being equal, an increase in public sector
saving means more investment and faster growth in the capital stock.
Net capital inflows reflect net imports. Along with international
flows of goods and services, financial capital flows back and forth between countries.
If the value of imports exceeds the value of exports, then other things (namely
investment, saving and the budget surplus) being equal, capital inflows will exceed
capital outflows; otherwise there would be no way of paying for the excess of imports
over exports.
But, other things are not always equal. For example, an increase in either
private or public sector saving may have an effect on the amount of foreign financial
capital flowing into the country. One reason that might happen would be that an
increase in domestic saving would tend to push interest rates down here. That would
make domestic financial assets less attractive to foreign investors and make foreign
financial assets more attractive to U.S. investors. Thus, changes in domestic saving
and net foreign investment could offset one another.
Figure 3 shows each of the three sources of investment funds over the past five
years, each one expressed as a percent of GDP. Private saving includes the saving of
households and businesses. Public saving here reflects both federal and State and
local governments.
8 For the purposes of this explanation, State and local government saving is included in public
saving. Most of the variations in the public sector saving rate, however, are attributable to
the federal government.
CRS-9
Figure 3. U.S. Saving by Sector
25
20
15
Foreign
Public
10
percent of GDP
Private
5
0
1996
1997
1998
1999
2000
Source: Department of Commerce, Bureau of Economic Analysis.
In 1996, the public sector contribution to national saving was small – less than
1% of GDP. By 2000, public sector saving had risen to 5.3% of GDP. Over the
same period, private sector saving fell from 16.5% of GDP to 13.0%. Net inflows of
foreign capital rose from 1.4% to 4.3% of GDP. Total funds available for investment
in the U.S., from all sources rose from 18.7% to 22.6% of GDP.9
Saving from domestic sources, public and private, rose from 17.3% in 1996 to
18.8% in 1998, but fell to 18.3% in 2000. At the same time, because of rising inflows
of foreign capital, the claims of foreign investors to income from the domestic capital
stock were increasing. In the 1980s, large inflows of foreign capital were typically
associated with large federal budget deficits which added to domestic credit demands
and pushed up interest rates. More recently, other factors have clearly been at work.
Two reasons have been suggested for the increased foreign capital inflows at a
time of rising public sector surpluses. One is that because the domestic economy is
doing so well – in particular, productivity growth seems to have accelerated – there
has been a surge in profitable investment opportunities. The other is that even in the
absence of a increased yield on U.S. assets, foreign capital might have flowed here
because of a perception of increased risk in countries where the capital might
otherwise have been invested. In this case the U.S. serves as a ‘safe haven’ for
foreign capital.
9 Even though the federal budget was not in surplus until 1998, the public sector saving rate
was positive beginning in 1996 because of the surpluses of the state and local governments.
CRS-10
The recent increase in investment spending has been made possible by both the
increase in national saving and an increase in foreign capital coming into the country.
The economy will likely be more productive in the future than it would have been in
the absence of any increase in saving but a fraction of that increase in output will have
to be paid out to foreign investors as either rents, interest, or dividends.
Reducing the Federal Debt
Perhaps the most obvious effect of running federal government budget surpluses
is a decline in the federal debt. From an economic perspective, however, the measure
of debt that matters more is not the absolute level in dollar terms but rather the debt
relative to total output, or GDP. From this perspective, the debt has been falling since
1993.
A steadily growing federal debt, as was the case until recently, is not by itself a
cause for concern. But as long as the federal debt grows faster than GDP, interest
payments on that debt will constitute an ever-increasing share of total federal
spending and of GDP. If investors should come to expect that the debt would grow
faster then GDP indefinitely, and that the debt to GDP ratio would continue to rise,
they might eventually become unwilling to buy new issues of federal debt.
In the long run, the relationship between the growth rate of the federal debt and
the overall rate of economic growth is critical to financial stability. Perpetual growth
in the debt in excess of the rate of economic growth is an inherently unstable situation.
It is likely that investors would become unwilling to buy federal debt issues sometime
long before all of GDP was accounted for by the interest payment on the federal debt
because of growing doubts about the government’s ability to raise sufficient revenue
to pay the interest on that debt.10
Whether or not the debt-to-GDP ratio is on such an explosive path depends on
the rate of interest and the rate of growth of GDP. Consider the case where the
budget is in balance except for the interest payment on the debt. That is, the budget
deficit is equal to the interest payment. In this example, the debt would grow each
year by an amount equal to the interest cost of financing the debt; thus the growth rate
of the debt would equal the interest rate. If the interest rate on the federal debt
remains above the economic growth rate, then the debt would grow faster than GDP
and the ratio of debt to national output would rise. The converse is also true; as long
as the interest rate on the debt remains below the growth rate of GDP, then the ratio
of debt to income will fall.11
10 Should the federal government be unable to find private sector buyers for its securities there
are two possible outcomes. First, the federal government would simply be unable to meet all
of its obligations. Second, and the more likely of the two, rather than allow the federal
government to default, the Federal Reserve would buy those securities. Although the Federal
Reserve is independent and under no legal obligation to ensure the sale of government
securities, it might well step in to avert default. Should it come to that, the threat is not one
of government insolvency, but rather of inflation.
11 Inflation can cause both the interest rate and the growth rate of GDP to rise. Interest rates
(continued...)
CRS-11
Thus even with a budget deficit, the ratio of debt to national income can fall. For
the U.S. the recent peak level of the federal debt relative to GDP was reached in 1993
at 49.5%, when the budget deficit was $255 billion. In 1994, even though the deficit
was still over $200 billion, the debt fell relative to GDP. Figure 4 shows the level of
the debt-to-GDP ratio since 1970.
Figure 4. Federal Debt Held by the Public as a Percentage of GDP
50
48
46
44
42
40
38
36
percent
34
32
30
28
26
24
221970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000
Source: Congressional Budget Office.
During the period shown in figure 4, the budget was in deficit most of the time.
Clearly, variations in the ratio of debt to GDP do not depend solely on whether or not
the budget is in surplus or deficit. As long as the budget is in deficit, however, the
ratio cannot fall to zero. But, for the sake of long term economic stability what
matters most is that the ratio is not perpetually rising.12
11 (...continued)
usually reflect investors’ inflation expectations, but a substantial rise in the price level that
was unexpected by holders of existing debt would raise nominal GDP but not the level of
outstanding debt and the debt-GDP ratio would fall.
12 The possibility that eventually all of the federal debt held by the public would be paid off
raises a number of interesting questions. For example, the Federal Reserve manages the size
of the money stock by buying and selling Treasury securities in its open-market operations.
In the absence of a market for federal government debt, the Federal Reserve might have to buy
and sell private sector assets to conduct monetary policy. The absence of federal government
debt could also affect the banking sector. Banks hold Treasury securities among other assets
and the fact that they are considered to be riskless assets reduces the overall risk associated
(continued...)
CRS-12
Conclusions
Economics, generally speaking, is neutral with respect to whether one saving rate
is better than another. Ultimately, it is an expression of the public’s relative
preference for present versus future consumption. But, for the time being, the public
sector is an important contributor to the pool of saving.
Irrespective of whether or not it is better to have a budget surplus than a deficit,
the budget has clear-cut consequences for the economy. In the short run, the fact
that the budget is in surplus, makes little difference to economic performance. In the
short run, it is
changes in the surplus that can affect the rate of economic growth. An
increase in the surplus would tend to be contractionary, while a reduction in the
surplus would tend to be stimulative. Those effects, however, are likely to be short
lived.
In the long run, a budget surplus represents an addition to national saving.
Higher saving means a shift from present to future consumption. Consuming less now
means greater investment now, a higher level of output of goods and services in the
future, and thus, more to consume in the future than otherwise would have been the
case. To the extent that greater investment is financed by importing capital from
abroad, however, some of that higher output will be paid to foreigners.
A budget surplus also means that the outstanding federal debt is falling, in
absolute terms. A rising debt-to-GDP ratio eventually poses the risk of accelerating
inflation. While it is not necessary for the budget to be in surplus for the debt-to-GDP
ratio to fall, a budget surplus and a growing economy at least put that possibility on
hold.
12 (...continued)
with banks’ portfolios. If risk free assets are unavailable, adjustments to these portfolios
might be necessary to avoid increasing portfolio risk. See: U.S. Library of Congress,
Congressional Research Service,
What if the national debt were eliminated? Some economic
consequences, Report RL30614, by Marc Labonte.