Effect of Government Debt on the Economy
Public debt is a debt of federal, provincial and municiple government. Canada owes 83.5% of GDP 2010 estimate.
21.2% of canada's debt is foreign owned. The effects are:
1. decreased ability to borrow - the more debt you have the less ability you have to borrow because it's less likely for the country to pay back. It is too risky to lend to you again.debt increases the percentge of GDP and it becomes more difficult to service the debt. It also becomes hard to find who will agree to lend to your country.
2. Increased interest rate - e.g Grecce 10 year bond is 35% interest rate and Canada 10 year bond is 2.08% interest rate.if anyone will lend to the country, they will force them to py higher interest rates and higher interest rates crowd out investment spending and suppress economic growth. The down side you can't pay it off.
3. Increase taxes-(less government spending and sell government assets) if this is too aggressive, it will push your economy back to recession.It slows economic growth.
4. Increase money supply - The last resort for funding a national government when it has deficit spending and difficulty borrowing is to Print bank notes or increase money supply through quantitative easing. The downside it devalues your currency and leads to inflation
When the economy is experiencing a recessionary gap, the government will likely increase government spending and/or decrease taxes to stimulate the economy. The increase in government spending and the decrease in tax revenue (whether caused by lower taxes or less income to be taxed) will probably lead to a budget deficit that will be added to the national debt. While increased government spending and/or lower taxes can increase aggregate demand and real GDP as well as increase national income according to the spending multipler, government debt is not without side effects on the economy(1).
Government debt decreases a country's ability to borrow because countries who would lend face the risk that the country will not be able to pay them back (2). A decreased ability to borrow, forces a country to agree to higher interest rates that are naturally more difficult to pay (3). If a country can't afford to pay the interest on its debt, it has to increase taxes, sell assets, and/or lessen government spending (4). The government's last resort is to print money which leads to inflation (5).
One effect of government debt on the economy is the potential crowding-out effect which is related to the rise in interest rates caused by the government borrowing. The crowding-out effect is the concept that when the government borrows money to run a deficit, interest rates rise and this rise in interest rates causes private investment spending to decrease. This decrease in investment spending causes aggregate quantity to decrease (6). The other aspect of the crowding out effect is that higher interest rates attract foreign investment in an economy that has flexible exchange rates. When foreign investment increases, demand for the dollar increases, and the dollar appreciates. When the dollar appreciates, the country's goods and services become more expensive to both itself and other countries. Therefore, exports decrease and imports increase, causing an overall decrease in net exports (7). Because investment spending and consumption spending are reduced, the spending multiper is also reduced, causing government spending to result in less of an increase in national income (8).
Furthermore, the more foreign-owned debt, the greater the problem for a country's economy. Foreign investment is attracted by the high interest rates. If the national debt is seen as too large (as it was in 1995), private companies offer low ratings for government bonds sold globally. Then, the portion of the money to pay off foreign-owned debt increases, flowing out of the country (9).
Another effect of government debt is "the income redistribution effcts of large interest payments" (10) on internal debt (debt owned within the country). If the government raises taxes to pay off the debt, Canadians pay taxes which are used to pay off the debt and which they receive back in bond repayment. The result is that essencially all Canadians pay x amount to pay off the debt but only some Canadians— usually mostly the rather wealthy— receive x amount back (11). Paying interest can redistribute income.
An additional problem of government debt is that the government has to designate funds for paying the interest on the debt before it can assign funds to other important demands (12). Although running a deficit has helped it to address other demands, having to pay interest on debt hinders its ability to give as much attention to demands on the economy and "reduce[s the] ability of government to meet the needs of its citizens" (13).
Finally, (and less importantly considering that governments want to be re-elected) the ability of the federal government to theoretically and legally run as high of a deficit as it wants can encourage the government to become thriftless and intemperate (14). The big deficits that would result from such negligent conduct would have negative effects on the economy.
Endnotes
(1) Dr. Stephanie Powers, Fiscal Policy and Debt (presented at Red Deer College, April 4, 2012).
(2) Ibid.
(3) Ibid.
(4) Ibid.
(5) Ibid,
(6) John E. Sayre and Alan J. Morris, Principles of Macroeconomics, 6th ed. (McGraw-Hill Ryerson: Toronto, 2009), 391.
(7) Ibid.
(8) Ibid., 392.
(9) Ibid., 400.
(10) Ibid.
(11) Ibid., 398.
(12) Ibid., 400.
(13) Ibid.
(13) Ibid.
Public debt is a debt of federal, provincial and municiple government. Canada owes 83.5% of GDP 2010 estimate.
21.2% of canada's debt is foreign owned. The effects are:
1. decreased ability to borrow - the more debt you have the less ability you have to borrow because it's less likely for the country to pay back. It is too risky to lend to you again.debt increases the percentge of GDP and it becomes more difficult to service the debt. It also becomes hard to find who will agree to lend to your country.
2. Increased interest rate - e.g Grecce 10 year bond is 35% interest rate and Canada 10 year bond is 2.08% interest rate.if anyone will lend to the country, they will force them to py higher interest rates and higher interest rates crowd out investment spending and suppress economic growth. The down side you can't pay it off.
3. Increase taxes-(less government spending and sell government assets) if this is too aggressive, it will push your economy back to recession.It slows economic growth.
4. Increase money supply - The last resort for funding a national government when it has deficit spending and difficulty borrowing is to Print bank notes or increase money supply through quantitative easing. The downside it devalues your currency and leads to inflation
When the economy is experiencing a recessionary gap, the government will likely increase government spending and/or decrease taxes to stimulate the economy. The increase in government spending and the decrease in tax revenue (whether caused by lower taxes or less income to be taxed) will probably lead to a budget deficit that will be added to the national debt. While increased government spending and/or lower taxes can increase aggregate demand and real GDP as well as increase national income according to the spending multipler, government debt is not without side effects on the economy(1).
Government debt decreases a country's ability to borrow because countries who would lend face the risk that the country will not be able to pay them back (2). A decreased ability to borrow, forces a country to agree to higher interest rates that are naturally more difficult to pay (3). If a country can't afford to pay the interest on its debt, it has to increase taxes, sell assets, and/or lessen government spending (4). The government's last resort is to print money which leads to inflation (5).
One effect of government debt on the economy is the potential crowding-out effect which is related to the rise in interest rates caused by the government borrowing. The crowding-out effect is the concept that when the government borrows money to run a deficit, interest rates rise and this rise in interest rates causes private investment spending to decrease. This decrease in investment spending causes aggregate quantity to decrease (6). The other aspect of the crowding out effect is that higher interest rates attract foreign investment in an economy that has flexible exchange rates. When foreign investment increases, demand for the dollar increases, and the dollar appreciates. When the dollar appreciates, the country's goods and services become more expensive to both itself and other countries. Therefore, exports decrease and imports increase, causing an overall decrease in net exports (7). Because investment spending and consumption spending are reduced, the spending multiper is also reduced, causing government spending to result in less of an increase in national income (8).
Furthermore, the more foreign-owned debt, the greater the problem for a country's economy. Foreign investment is attracted by the high interest rates. If the national debt is seen as too large (as it was in 1995), private companies offer low ratings for government bonds sold globally. Then, the portion of the money to pay off foreign-owned debt increases, flowing out of the country (9).
Another effect of government debt is "the income redistribution effcts of large interest payments" (10) on internal debt (debt owned within the country). If the government raises taxes to pay off the debt, Canadians pay taxes which are used to pay off the debt and which they receive back in bond repayment. The result is that essencially all Canadians pay x amount to pay off the debt but only some Canadians— usually mostly the rather wealthy— receive x amount back (11). Paying interest can redistribute income.
An additional problem of government debt is that the government has to designate funds for paying the interest on the debt before it can assign funds to other important demands (12). Although running a deficit has helped it to address other demands, having to pay interest on debt hinders its ability to give as much attention to demands on the economy and "reduce[s the] ability of government to meet the needs of its citizens" (13).
Finally, (and less importantly considering that governments want to be re-elected) the ability of the federal government to theoretically and legally run as high of a deficit as it wants can encourage the government to become thriftless and intemperate (14). The big deficits that would result from such negligent conduct would have negative effects on the economy.
Endnotes
(1) Dr. Stephanie Powers, Fiscal Policy and Debt (presented at Red Deer College, April 4, 2012).
(2) Ibid.
(3) Ibid.
(4) Ibid.
(5) Ibid,
(6) John E. Sayre and Alan J. Morris, Principles of Macroeconomics, 6th ed. (McGraw-Hill Ryerson: Toronto, 2009), 391.
(7) Ibid.
(8) Ibid., 392.
(9) Ibid., 400.
(10) Ibid.
(11) Ibid., 398.
(12) Ibid., 400.
(13) Ibid.
(13) Ibid.