Question

Try the following exercises to better understand how the national debt is related to the government budget deficit.

1. Assume that the gross national debt initially is equal to $3 trillion and the federal government then runs a deficit of $300 billion:

a. What is the new level of gross national debt?

b. If 100 percent of the deficit is financed by the sale of securities to federal agencies, what happens to the amount of debt held by the public? What happens to the level of gross debt?

c. If GDP increased by 5 percent in the same year that the deficit is run, what happens to gross debt as a percentage of GDP? What happens to the level of debt held by the public as a percentage of GDP? (You will need to figure out which is growing faster, GDP or the gross debt, and then GDP and debt held by the public. If gross debt is growing faster than GDP, then gross debt as a percentage of GDP will increase.)

2. Now suppose that the gross national debt initially is equal to $2.5 trillion and the federal government then runs a deficit of $100 billion:

a. What is the new level of gross national debt?

b. If 100 percent of the deficit is financed by the sale of securities to the public, what happens to the level of debt held by the public? What happens to the level of gross debt?

c. If GDP increases by 6 percent in the same year as the deficit is run, what happens to gross debt as a percentage of GDP?  (You will need to figure out which is growing faster, GDP or the gross debt. If gross debt is growing faster than GDP, then gross debt as a percentage of GDP will increase.)

Answer 1

1) a) If the national government has a debt of $3 trillion and adds a deficit of $300 billion the new debt will be $3.3 trillion dollars. The new fiscal deficit will add up to the already existing debt.

b) The amount of debt handled by the public will increase because all the debt has been serviced by the sale of bonds to the federal agencies. Public debt is the amount owned by the government and the sale of securities does increase the burden on government. Gross debt will still increase by the deficit amount + any interest rates offered with the securities.

c) A $300 billion debt is just 10% of the total debt which was $3 trillion. And because the Gdp has increased only 5% the growth of GDP as compared to Debt is less. This will increase the Debt to GDP ratio i.e. debt held by the public as the percentage of Gdp has increased.

2) a) New gross national debt is $2.6 trillion.

b) Public debt is same as federal debt or the government debt if the whole deficit amount is financed by the sale of securities to the public, it will still increase the public i.e. government debt as the government has to pay the public. (Total amount + any interest on securities offered)

c) As a debt of $100 billion is just 4% of the total debt and the GDP has increased by 6%. The increase in Gdp is more than that of increase in Debt. This will decrease the debt to GDP ratio i.e. debt will decrease as a percentage of GDP.