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The ('oi:gressi0n:il Reseurcli Service works exeiiisiveiy for
the Coiigress. conducting researeli. ;m:ilyzing iegishition. and

providing inforinzitizm at the request of Committees. Mem-

bers and their SI1lTTS..

The Service nizikes such resezireli zwztihihie. without p:irti.x:m
bias. in many forms including studies’. reports. c0mpii.itit.W.ns.
digests. and bziekg,round bi‘iet‘iiigs. Upon request. the (‘RS
assists Committees in ziiizilyziiig lei:i;sl:itive prO];«0SZlT.\‘ and

_ issues. and in {l$$CS3Tl1g the pos;sil>le effects of these pmposuls

and their ;:|tern;itives. The Service's senior :€DCL‘iLlTi\'I\‘ and sub-
ject :m;.iiysts are also avziilubie for pL‘.'.\‘Ol'l{iT L'()n\iUTT;HT()Ii5 in
their respective fields of expertise.

CR8 -% 1

THE NATIONAL l')E13'1‘: A DISCUSSION 0}? 'J'II}}fl ISSUES IN\~’OL‘v'ED

Table of Contents

Pme.
—......-._.A..~.
IQ I‘]X]trO(.iLlCtiOr‘CuCOCOIOCOIOOOIOCCOOOOOOIOCIOICOflOOOOOOIQO 1
II. A The Development of lilconomic PCI‘C.€:ptiOr‘1S onthe  
NéltiorzyfiiDebtIIOOOOOOIOOOOOOOOOOCCOOOOOIOOAOIOOOOCOCO 
Ike      0 0 0 n 0 a I o  o 0 o n 0 O 0 u 0 n o 0 o 2
B. The Cont.ez‘m30raxf_3' Point of \"icw . . . . . . . . . . .- . . . . . . . 6

III. The Na_tionz.11. Debt and the U. S. }?IA(:(m01‘n_V: Some
C.T()I1‘1}3:’{I‘i-801.]-Sonooooooooooooooooooooooooooooohoooouoao 7
IV. 1\1isc:onceptions About thc: L\’:1tic;na1 Dmat . . . . . . . . . .' . . . . . 9
A. The Analogy Between I~‘an1i.ly and Z\Z;>.tiona1 I.)ebt  . . . 9
13. }3orrc>wir1g Versus Tz.:xati<:>n . . . . . . . . . . . . . . . . . . . . . . . ’ '11
C. Income 1{0di.stributiou . . . .. .  .   .  .  .. . 11
I). National Debt I3urdem3 zmd ()urf C£r‘z1I“xdc:hi}.drem . . . . . . . 12
V. The Nzixticimal l})ebt emd lnflatnion . . . . . . . . . . . . . . . . . . . . . . . . 13
\‘rIo  r:)(~.,-fficit00.000000000004100'0oooOo;O0IO0O¢fi‘O 
A. The Nature of the CI<3r1tr'c>\'cI*s~3)* . . . . .‘ . . . . . . . . . . . . . . . . 19

B. Piczkzing L1 Side: Szxxringgs \’<«#rsus3 Investment . . . . . . . . . . ‘33

Vrllo SuInrI1aI“y"oooocnootcoonaoccoooooooooooooooooooooooooua -4

Tliiil N.‘\TI('.)i\'AI.. D1{‘.B'I‘: A {)ISC1?b'SiOf\‘ Of’ T111‘) ISSUES IN\="Ol,,\"i'Sl)

I.A I Int.r0duc_:tion

The pra<:ti<*.e '01‘ goveimment b0rrowin,<g from the public to finance

its activities has been 21 c}.ontx‘ov<2rsia1 urea for decades- The shades

of opinion on national ‘debt have raniged from those’ who comieimi deficit

financing as an unmitig:at.<':d evil éventt1a11_y 1c.=ading_; to impoverishmr:nt
and bank ruptcy to those who view :-1 risihg national debt; as an iniiicatox‘
of pijospk:~rit_y' and a stirmziator‘ of eccmomic growtih. Why  there such
a wide span of opinion‘? 1nter‘pretat:ions of national debt statistics are
very 171t1<"2h :1 part of <;mc2’s <;mt;lo<>1; zmci thini«:in_:3; on ggc_>\/ernme:-rnt spending
anritiiit [f)I‘()}L)t3,I“ m‘>1e of _g()VCi“I'1I‘i1(‘tlt in the ecomwmy. S}'}C‘3.kil”1.{{ in gen-
e[‘£»‘L1.t€I‘l“l‘1‘3, the ‘less scope. Z:1€‘f()I:‘dti:d g<.>vernzh«;~nta1 intervention in
tlm ec:”ori<:miy,A the less favor‘z1hic is the outlook on deficit spending.

This paper‘ is an attempt to int.eg'1*.ate a grezit deal pf diverse ma-
tobizzil oh‘ the natiouzii debt into :2 cmhesive form. It is meant to serve
as ti.1i)riefing for tho:—,-;e not far‘\iili.z1h with the tS:3ttt3S <:ng‘endert:<i inf.’ the
nzitional r.iee)bt and cieficzit sy>en<.iim;. To thga exten_t that we rn:>.y have
atterhpteci to ir1t€:jggt‘z1te 1:00 1‘mi«:.:himaterial, the o})j;ec.tive of r.:0h<2sive~—
m3s.~3_ rnzyy lizivé been é<)1“iihrm'nis«3<;1; Indeed; certain '3<3ctions of this

paper could stzmd alone :19; examinations of specific parts of the 2_;«:en—

eral topic.

This _0:.1p::~r is rmtintended to ]‘)1"0Vit'.iE’.  specific: answer‘ to the ques-
tiori, "llow lsig can thee. x'1ati(m:11 <.i»:z‘ot. b-3(:ome'? " Tr) «'mr 1<1i<.>\v1e<J<.;r3. no
one has attempttzd to specify an L~1IT1()‘tlH1‘. in .<ms\\rm~in_:_:( this qiiestitixi.

liuher, the <liscussim‘1'1.‘t3v<>1ves €H‘()Llfi(_l the fiI'1£;1I"tCiI1_{I of the deficit. in :1

given year» and the effect itm:-1y have on the trccinciriiy.

/

Because of the widaz range of subjects cc.»/ered, this paper is not
intended to be a definitive, comprehensive £."Cl.ld)’; especially in the
area of macroeconomics, we have oversimplified. Hriwever,

this is in line with the objective of the paper} Those interested in

la more S()pl'li.‘.'5tlC‘.ai.€Cl‘ examination of the econ<‘:mi_r:s involved should

refer to texts on the subject. For those seeking; more specific ma-
terial on the national debt, we refer you to two (.Ionigi"essi<>iml Re-
search Service multilit.hs—-74-1'72l3, Natiental Dmrt of the llnited_Stat.es:
Historical Survey and Analysis. land 75-1'l&.l}73, 'i5ui)li.c Debt Limit Leg'is-

lzition: A Brief l-listory and Some Arguments for and Agaizist It.

II. The Development of E(‘.()l“l()lT_l.l(? P<.~rcept*.ions on the Nsitionsil l_)eht

A. The Cl.zissic:.il Point of \«"i(-é\.v

The classical view goes l7€1(3k to the British and French clzissical
economists of the late eigghteenth ayhcl early nineteenth centuries. ln
their t.hinkin;_{, the government had only a very limited role to perform
in the economy. Lt-:-.git.iI"nately it should spend only for protection anti

. X A
certain cfujectts of "perm:-ment public benefit," e.g.. roads, canals,
etc. These t:X[.’.)Gn(iltLlI‘€3S should be paid for out of Current receipts;
the budget should be balztnced.

Underlying this prescription of a bzilanced l_)tir.l,get was 21 p1‘(_?SLlI‘l2p-
tion that government spemling; is unproductive and that the must. ef-
ficient allocation of productive res<_>urees could be attained only by
private spending in the as-suinalily competitive market. Individuals

guided in their buyin,r.;' and selluing‘ solely by the desire. to m:a.~;imi7.e

VV

(IRS - 1

their personal benefit would at the same time of necessity do what‘

the rnaiciniization of public good rind economic growth required. Thus
ggovernment spending, by interfering with the efficient allocations
achieved byafreelgg operating competitive market, was wasteful spend-
ing, most of which was splurged on irresponsible wars or on ‘main-

taining the pomp and circumstance of the ruling elite.

There  tI'i ‘- ;;§r‘:—3.I)d distinction between an individual borrower
and a borrowing government, that, in general, the former borrows
capital for the put pose of beneficial employment," the latter for
the purpose of barren consumption and expenclitiire. 1/

An individual is fully SC‘l’lSl.l')].€' of zmf.-' value of the article he
is coxisuiiiirig; it has probably cost him :1 world of labour, perser-
verzmce and ectonomy; he can easily balance the satisfaction he
derives from its consumption agaiiist the loss it will involve. But
:1 government is not so immediately interested in rc;.§ularity and
economy, nor does it so soon. feel the ill conmqucnces of the op~
posite qualities. _f_3_/ '

Restricting government expenditures to current receipts served asa’

method of placing a brake on wasteful spending. Governmental re—-
sponsibility would he CllC(’)L1I'a§_{{13(.l since the governmcnit in financing
its activities, would be dependentsolely on its receipts.‘ V

The early economists were also concerned about the eifect of an
unbalanced budget on industry and commerce. They concluded that

government borrc">\vin,g; lei-sseneo‘ the amount of capital available to

Say, Jean Baptiste. A Trezitise on Politiczil i?Iconoiny; or, the
Production, Distribution, and Consumption of Wealth. (London)
1821. p. 418.

1:}

_:_a_/ Ibid.. p. 418.

(YRS - 4

industry for productive purposes. Deficit financing took money out

of the hands of nierchants, whowould have used’ it to further trade

~o-r enlarge the stock of capital, and placed it in the hands of the

government to be used inefficiently.
In further support of their antipathy to govei'nment borrowing, the
classical economists advanced a line of reasoningiwhich even today

underlies much of the publi.c concern over the size of the national debt.

“This line of reasoning is that government borrowing and spending is

analogous ‘ to private borrowing and spending. While this notion is

4 generally condemned by contemporary economists, it. continues to have

« appeal among the general public.

i Annual income twenty pounds, animal expencliture nineteen six,
result happiness. Annual income twenty pounds, annual e>;pen<li-
ture twenty pounds ought and six, result misery.

To the classical economists‘ way of thinking, this famous Dickens

maxim was just as applicable to ,<_jovernment as to ‘private families.

,T73c-onomic moral.ity required the virtue of thrift. Failure on ‘the part

of the public household to live within its income would result in the
same unhappy consequences as when individuals incur financial obli-
gations in excess of their means.

 . Should an individual take it into his head, that the more

  he spends the more he gets, or that his profusion is a virtue; or
should he yield to the powerful attractions ofpleasure, . . . he
will in all probability be ruined, and his exainple will operate upon

a very small circle of his ne:ig3hbours. But a mistake of this kind
in government, will entail misery upon milliousand possibly end

-i _ in national downfall and degradation. . . . Economy and order are
virtues in a private station; but, . in a public station, their influence

CRS - 5

upon national happiness is so immense, that one hardly knows how

sufficiently to extol and honour them in the guides and rulers of

the national conduct. _C'}_/

Early economists were also apprehensive about tax burdens which
they claimed resulted from deficit spending. Although opinion on the
exact nature of this burden varied, they tended to associate rising def-
icit spending with rising taxes. Later economists became more con-
cerned with the idea that the burdens of defic:it spending are shifted
to future generations. l

Briefly, the basic outline of traditional thinking on public debt man-
agement can be summed up as follows: That the principles of sound
financial management applicable to private households are equally ap-
plicable tothe public household, that public debt imposes interest
burdens paid for by higher taxes,’ that public debt constitutes a bur-
den passed on "to our grandchildren, 'j'
prodizctive and inflationary. V

Few of the classical economists supported completely all of the
above statement. Even in their earliest writings there were more
optimistic views of public debt. However, the generally shared per-
ception that, under some circumstances, public deficit spending re-
presents a normal and expected state of affairs is a development of

recent decades.

_._"-._=_/ Ibid.

that government debt is un-‘

CR3 - Ge

B. The Contemporary Point of View

 The shift in economic thinking away from the ideal of the balanced
budget was in good part occasioned by the depression of the early 1930's.
Economists increasingly abandoned their belief in the merits of a bal-
anced budget because tax increases did not, Kind apparently. could‘ not,
balance the budget. Deflation fed on itself instead of acting‘ as a cor-

rective to b1‘in,<,j{ a new period of expansion of private enterprise, and

extremes of unemployment and hungerdemanded relief.

Economists began to stt*Lz_qg;le away from the classical belief that

savin is must be accumulated b I each investor 3I‘iOi“ to his investment.
8 I) I

They laeéaii to accept the Keynesian notion that what was important
was thatfitotal savings equal total investmentp in an economicsystem.
If the government, through deficit spending, provided an outlet for sav-—
ings not being othnrwise employed in investments, income» could be gen-.
erated and the downward spiral of deflation caused by excessive savings
might be slowed or reversed. Economists could then contend that gov—-
ernment expenditures are productive in the sense that they generate
income, satisfy demands for public goods, and employ resources that
would otherwise be idle. This realization grew with the size of the
public sector, as the interdependenc_y of the public and private sectors -
became clearer. It provided a rationale for active government par-
ticipation in the economy, and did substantial tiamage to the classical

argument that government spending is inherently wasteful. and that

CH3 - 7

thet‘et’c>rc3 deficits, by runiovimjgtvapital from })r‘(f)CltlCllVt3 use, ri«-3<t<:s-
sarily Contriljutes to ncontymic: stagnati.c:.-»..,
National debt can be ‘gust as ef'f(=<.:t,i.ve :1 means of activating idle

savings as private debt. ‘ Not only does national débtserve as 21 method

of mobilizing; idle funds for‘ tisxzftil pt1l')llC purposes. but it provides

private invc:st0rs with earning assets reiaclily coiitrertible into bash.
Sticli an investnfient outlet is iznportant. to C.’(),!‘nl'l1\*:I"'L‘l’a.l. banks. trust funds
and other investors who reqtiire maximum safety as well as a good
return oninvesfnients. As :1 result, the national debt has bersome

;>a.rt of ourin:=.tion's financial systt-‘am.

Ill. The Nziitional Debt and the U; S. ltltmnomyz Sorne Comparismis

At the end of fiscal year‘ 1975, the na.tioxi:-11 (i(i3l;)t'StO(,)(i at 531513»; bil-
li0n.ii To und«2rstam;l the effect of the size of clebt on the et:c>1mmy,‘
it is first z'.~;<‘:é2ssar$r to I1V18.l{€3'S()i’}1E-3 ctompafisons of cltzbtand clebfi,
charges with the wealt_.h ancl iiictonie: of their nation.

Sil’1Ct’3 the end‘ of Wc>r'lc.l \Va:.‘ 11, the public debt as at percentage
of gross na_t.1'0n:1l prciduc;-t (GN15) lias fallen sigz1ifi(Ea.ht.l§'. From 3 ‘ziizgh

0f12S}.p<:r‘c<;nt of the GNP in 1948, it; has fallen to 33.8 percezit b_y

CR8-i8"

the end of fiscal year 1974. Because of theecononiic recession and

inflation, it is expected to rise to 37.6. percent of GNP by the end .

of fiscal year 1977. The interest paid to support the public debt each

year, the standard measure of the "cost" of the debt, has .t'luc-

tuated as a’ percentage of GNP. From a high of 2.24 percent

- in 1946, it fell to 1. 60 percent by 1986. Since then it has again risen

to 2.24 percent of GNP in fiscal 1975. If, however, we subtract
from the figure the $7,769 million in interest paidto the government
trust funds, the figure drops to 1.70 percent of GNP. This $7,769

million represents interest earned by trust funds on government secu-—

Arities owned by them. By law, trust fund surpluses must be invested

in Fede ral securities.

Some other statistics also provide a useful perspective on the debt.

For example, between December 19-45‘ and December 1974, the debt

of the Federal Government and its agencies increased by 80 percent,
During the same period, thedebt of State and local governments in-
creased 1,208 percent, that of corporate business 74.415 percent,
and 1 lat ofiindividuals and non-corporate businesses 1,509 percent.
Finally, between 1945 and 1974, the ratio of per capita public debt
to per capita personal income fell from 154 percent to approximately
41 percent.

On the bases ofsuch statistical comparisons most economists have

come to agree that, although the national debt and national debt interest

C RS - 9

I

payments appear‘ ‘Large in absohtte terms, when vieweci in the ertm-
text of the size of our‘ national economy, they are manageab‘e. At
current growth levels rno~3t economists see no danger of some sort

of national economic collapse due to the size of our national debt;

IV. t\1isconc:eptions; About the National Debt

A. The An.:11.o;1y Between I4‘;-1mily and National Debt

Most C()IH.(3l'hpO1"L'-1I‘y economists apprmzteh cautiously the idea that

there is; a valid analogy between per‘.<;on:_~11 and national debt. The t1‘adi-
f

tionat §_eec>nomi<‘. wisdorn pnr‘t.r'ayin;;{ any debt as intrinssicrallly ba«'l is

not applicable to national bud‘_qetin;;.

Debt, of Course, has at cost for either a govermnent or an indi--'

viduzil xv:-huge earner‘. But the 1)enefits Cf.-In justify the eosst. The better-
fits of private C(.)I’1:3L1X‘.1(’3I" debt are r‘een;3;x1i7..ed by the b<»..>1‘1‘n\m*: rmd by
the rm-.~1~eh:1nts and ntzmufnczturersv whose sales depend Unit. The ad-
vatutages of public debt are ecqtxztlly clear‘ to those who benefit froxn
programs fin;-tneed through ,g2;overm‘nent b(,)r‘1“owing. V

The national debt is prineipzttly an intemmlly held «:,1eht.’ That i‘s.V
we owe most; or it to oursselves. 'I‘axes im;.»n:sed to service the nrttienal.

debt are collected t‘rom s<;>rne Atxtte-r*ie:1r1s:«tnx'3 paid other Americans.

In many instances, t.ho.~3e taxed to sserviee the debt and.th(.>5-3e reeeivingg

interest payments are the same.

(IRS - 10

 exception to this is the slightly more it than 12 percent of the
national debt that is owned by foreign official institutions and citizens
of other countries. Fcireign ownership of the national debt has gzrown
rapidly in recent years.. 1 This is a natural consequence of increasing
wealth in other parts of the world.

The interest paid to support this forei.g'n-held debt is the only loss
of disposable income imrolvml in the national debt. ‘ Within the nation,
unlike 'withinafamily, everybody's borrowing is somebody else’s cred-
it. The burden placed on the economy is minimal.

Contempoiary economistslstress a second way in which public
debt differs from private debt. A family which continuously incurs
l.ar;;§ei deficits may endanger itscredit rating. An individual's credit
ratingyis for the most . part based on his limited amount of income and
wealth. As his g_c:bt grows large in relation to these assets. his

creditnors becornereluctant to grant additional loans for fear of failure

to repay. Unlike the individual, the debt—cax"rying capacity of the

United States is, for practical purposes; unlimited  the foreseeable
future. Securing. the credit ratingfiof the nation are the powers to
tax and to create curi*ency as well as a vast amount of real wealth.
Tliese are formidable assets which not even the wealthiest individuals
or the largest corporations haven For this reason the United States
cr'edit 1‘~a ti.i'1g is secure and a United States government bond is re-

garded as free of danger of default.

CBS - 11

 Borrowing Versus Ta:-:ation

Some writers criri-tend that government borrowing‘ imposes a bur-

den which would not be imposed by taxes. Economists acknowledge

that deficit spending may occasion difficulties arising from the pro-
cess of transferring resources from private to public uses. A However,
since public goods as weilas private goods are valuzible andin demand,

a burden in the economic sense can only be said to exist if the pub-

lic uses of resources resultsin a greater waste of productiveefficiency ’

than if those resources were employed in private use. i But such. ab
burden, caused by inefficient use of resources, ‘can occur with any
type  gcivernmenml. _spending, whether  or deficit f‘in:u‘:ced. \Vit.h
the ecjonomy operziting at less than full employment, this burden “should

not occur since, in theory, government deficit spending utilizes re-—

sources that otherwise would go unused.

(3. Income Redistribution

Another type of burden i’requently cited involves the redistribution
of income caused by interest paid on the principle of the debt. It is
contended that these payments are taken from the less well-off to pay

the more advantaged, since it is the more £1d\’23.I'ltZ1g€-:d who own interest

bearing assets such as Federal securities. The effect wotild be that L

of :1 regressive tax at variance with the notion of equity expressed in
our progressive income tax system.

It seems unlikely that there is a significs.nt relationship-between

cns - 12

the taxes; an inclivici'ti.:=-.3. or institution pays to support the debt, and the

interest payments they receive. e'I‘here does exist a correlation be-

tween income and overall interest received. But this includes interest

from many sourcesiother than U.S. Government securities. Even
if debt financing could be shown to ll.‘-ZIVC the postulated regressive ef-
fect on inccmie distribution, several factors would work to minimize
it. I’.irst, the natir>nal_debt isvery widely held. . Nearly everyone,
either directly or indirectly, owns part of it, and thereby receives
some interest. Directpownership involves the purchase of savings
bonds or other _government securities. Indirectparticipation occurs
Ul1”‘O1If_;'ll ussocizitions. such as benlis and insurance conipanies, that
invest in large denomination 'I.‘reasury securities. Even wider parti-
cipation occurs through ownership of public debt securities by the
Vecleral trust funds.  

Secondly, this postulated regressive effect would be offset by the
progressifve na.t:,ire of the income tax structure. Th:;i.t is, ‘those who re»
ceived more interest would probably be paying;»; more taxes. Interest on

Federal debt issues is tanzsble at the same rate as other personal. income.

I). .N£lU.OIl{1!.-qDC‘biC Burdens and Our Clramlcrliildreri

Some have €1dV'2.’.n(.‘.t3d the zirgument that future»generation.s will have
to repziy the debt we incur. This burden (if, as we discussed earlier,
it is at burden) cannot possibly be shifted to future generations. The

present generation can employ only resources currently existing. It

CRS -13

cannot utilize those which do notyyet exist, thereby depriving future
generations of them. It is the present generation which must utilize
fewer private goods in order to have more public ones.

Economists emphasize that thoughthe debt will not be retired by
the present generation. neither will the next generation have to pay
for it. V Although the individual securities will be paid off] as they ma-
ture, they can always be replaced with new ones. There is no need
everto pay off the national debt. Even if the national debt were to
be repaid by the next gexieraticm. that same generation would receive
the payments. The next generation will inherit the securities xvhich
represent claims against the national debt as well as the respr:>nsibilit_y
to repay the debt. By the same reasoning, if we of this generaticm
were to repay the debt, we could not say that our children would be
better off.‘ They would inherit cash or securities less secure thain
those issued by the Federal Government. Again, it should be pointed
out that this does not apply to that part of theidebt that is foreign-

\
owned.

V. The National Debt and Inflation

It is usually assumed by the layman that there is always :1 direct
and significzint correla.tionbetween deficit spending and inflation. Con-—
temporary economists feel that this assertion of a necessary link be-

0
‘s

tween the two is based on an incomplete understanding of government

Gina» 14

spendinganuithe causes ofinfknion. \VhiH2increased governnunn spend~
ing was a factor in the vca.-r~_y serious inflatiori ercperieiicted in our his-
tory,the hfi1aU0n‘waszflfle iogyxnv u)chr0nk:proporfions due u3the
stfessyflacedcwiproducthm:capacUg'by perkxksofxvarzpuithe pecuhér
inabUiQy<fi'goverfinunn.a1 suchtinKw;to#direct:Hs econonfix:afihirs
to alieviate infiatnun.

On the basis of historical cl:-Lia, ecoxiomists have c0iic1u<i_ec;1 that there
is no observable systematic i~c:1ati0nbetween large gbvernnient deficits
andxfisnugynfice levels. 11n2tab1e bekmu hnuksio confhfn Hus by

C0l’Tl}_.”)l.1I‘il’1g fiscal ‘\'eai~ ticficits or surplusizes with the change in the
i :

. 4
v

conéunmerynficeindex for flueassocnned cakMvku‘year.

Surplus or Deficit

Year   (hibinions) ‘Percent(3hangein CTN cw-
1951 +6.1 F + 5.9
1952 -1.5 + .9
1053 . ~6.5 4 .6
1954 ~1.2 ~ .5
1955 9 - -1.0 + .4
1956 +4.1 + 2.9
1957 +3.2 '+'3.0
1958 »2.S) + 1.f¥.
1959 ~12." + 1.5
1960 +.3 4.1.5
1961 53.4 + .7 m».
1962 ~7.1 + 1.2
1953 -4.8 + 1.6
1984 , -5.9 + 1.2
1965 -1.6 + 1.9 9
1966   -3.8 + 3.4
1967 ~8.7 4 3.0
1968 ~25.1 + 4.7
1969 43.2 + 6.1
1970 -2.8 +.5.S'
1971 ~23.0 , + 3.4
1972 -23.2 + 3.4 "
1973 -14.3 + 8.8
5 +12.2

1974 ' -3.

CR8 - 1.“;

liluidget deficits and inflation %cannot be correlated either in direction
or magnitude. . There have been butiget surpluses correspoziding
with large’ inc-rea.~.»:es in the CPI, as in 1969. There have been
large deficits when only small increases in t.he’C'Pl were reported,

and small defivits with large increases in the CPI. Compare the

years 1971 and 1972 with 1974. In some years, as in 1968, the

traditional relationship has appeared valid. This does not mean that
Federaldeficit spending is not a factor in inflation, but it does in-
dicate that other considerations are also importaxit.

The classical. con-iition of inflation, as it relates to I*‘ederal spend-~
ing. occurs inthe fc>ll«,>»viin;:; mzlmnier: fiovernment cleficit spending‘ adds
a-:lrlititon:.ili .dez;nands for goocls and services to the normal level of de-
mand. This increase in tlemand stimulates a greater amount of pro-
duc:tive_a<:tivity, .€l11[_)l():,’-lhg more persons at higher wages. Taxes tend
to lag behind wage increases, leaving workers with augmented dis-
posable incoznt--ts. They aim: now able to buy more goocls and. services.
However, the amount of goc)d<3 and services available for private <>on~

sumption does not increase at a rate com1.>limentary to increases in

income, because resourcies which normally would go for private con-

‘_:5l,lI‘1'lpl‘.lOl'l are being transferred to public: uses. Tlius, too many dol-

lars are _cha.<*.ing too fiew goods. and prices are bid up.
'l\/lost eeonornists would say that to ascertain whetlier a given in-

crease in ‘rovernment saendinrr (or )I‘lV£1l€ s iendinrr for that matter)
in «*7.» In V

ens - 16

will occasion inflation, it is necessary to look at the factors of sup-
ply and demand operating. i

Under conditions where the economy is depressed, there are many
idle resources. Deficits would be more likely to lead to an increase
in production and employment than to inflation. As the government
spends more, additional workers will be hired and unused productive
capacity will be put to use. As employment increases, consumption
will also increase. This will set off another round ofemployment,
production and spending‘. At the onset, prices may rise sliiglitly, but
as businesses compete for more sales, more unemployed factors of
production will be utilized to extend the supplies,‘and prices will sta-
bilize. The important point is that demand increases only as pro»
duction grows. l)emand does not exceed supply as in the classical
case of inflation described above. In the opposite situation of economic
growth, increased f_?‘,;'erzmient spending in the absence of an offsetting
decline in private spending has the potential to be inflationary.

Finally, let us examine the source of the current record deficits,

‘ \. ‘V

keeping in‘ mind the conditions under which deficit speinding may or
may not be inflationary. Current economic theory estimates that each
percent of unemployment over four percent costs the }3‘ederal Govern-
ment approximately $l6 billion. (Tax revenues decuine $14 billion
as income drops. Outlays increase by $2‘: billion for employmont-re-
lated programs such as food stamps and unemployment; benefits.)

Therefore, the current condition of the economy itself (with unem-

CRS -917

ployment conservatively estimated at 8 percent) makes a budget def-
! »  ’
licit of $64 billion almost unavoidable. Yet. we can see from the above

3 .
idiscussion this deficit need not be ‘ini;'l.at.ionary. That part of‘ it gen-
erated by declining revenues ($56 of the $64 billion in our example)

does not represent an inflationary increase in government demand for

goods and services. The  billion that does represent increased spend-

ing only partially offsets the decline in private demand it is supposed
to accommodate. Some responsible economists, in fact, have argued
that the expected fiscal. 1976, deficit will have, at best., a neutral effect a
on the economy. They point out that if the deficit is toassist in the
recovery, it must be large enough to generate additional demand--
not jiist replace that lost to the recession.

The above discussion reflects traditional t3(.‘.(‘)Z‘1(})I7\.:C arguments that
were, until recently, generally accepted as true. Irlowever, the recent
phenomenon ofieconomic reces.~;ion coupled with inflation has caused
these arggunients to be questioned. In the conte:«<t in which it was first
constructed traditionzll theory may still be valid. But changing cir-
cumstances have added variables for which it has trouble accounting.

A significant part of the inflation we have experienced recently
has been I:-ausecl by shortages of supply instead of increased demand.
This trend has been especially noticeable inthe areas of foodand petro-

leum products. As previously discussed, inflation.tliotiggglit. to result

4/ On January 15, 1976, Nancy Teeters, Assistant Director for Eco-

" nomic Analysis of the House lfiutilgget Committee., in a Congressional
Research Service seminar on l.)i1<il5geti1ig, estimated that if the deficit
ran to $75 billion in fiscal year 1976, 3,1734 billion of it would be at-

tributable to these recession—-induced chaniges in receipts and outlays.

CRS - 18

from deficit spendingis usually associated with excess demand.

In pastrecessions, prices have dropped as demand fell, and busi-

nesses have usually increased their prices when rising demand signaled

the endof recession. This time, the list prices of most industrial

goods did not decline, and businessmen began to raise them very early

in the recovery. Businessmen explain these trends by point.in_.<_g to the
failure of their costs to decline during this recession, as they have
in past ones, due to the rising costs of energy, labor, and raw ma-

5/
terials.

Part of the explanation. may also lie in changes in the economic
structure of this country. Many businessmen perceive that a large
number of industries have become oligopolistic in nature. Prices
in such industries generally fluctuate less widely than-those in more
competitive industries. Each seller hesitates to lower prices because
he knows that his few competitors will immediately match the cuts,
leaving him with approximately the same share of the total market
and lower profits. This hesitancy has also been encouraged by an

unusual willinrgness on the part of consumers to tolerate higher prices.

5/ Anderson, Harry B. Price Rise Resurgence Despite Idle Capa--
city Stirs Debate on Causes. Wall Street Journal, August ‘.22, 1075:
1, 6.

6/ Anoliggopoly is a type of market structure in which a small num-
ber of firms supply the major portion of an industry's output. The
best known example in the U. 8. economy is probably the automobile
industry‘. ‘

7/ Q3.  Anderson.

7/

CR8 - 1'4

The relationship between deficit spending and inflation postulated
by economic theory is a viable one. Butin the simplified form by
which it is usually applied by the layman, i.e. that deficit spending
directly causes inflation, it cannot be empirically verified. inflation

results from the interaction of a member of variables, of which def-

' icit spending is only one.

VI. Financing the Deficit

The evidence overwhelmingly supports the position that the total
size of ou-r national debt and the cost of supporting it pose little,
if any, difficulty for our economy. On the other hand, it is possible
that the intrusions of the Treasury Department into the capital marlrtets
to obtain funds to support new debt and to refinance old debt has the
potential to cause disruption in our economy. Whether or not such
damage will occur, under what cirr;t1:ustanees it could occur, and how

serious it might be is a controversial subject.

A. The Nature of the Controversy

The total funds available to all classes of borrowers consists of

the total of business savings, personal savings, and inflows of foreign
8/

funds. "' This is theamount available to finance ail investment plus

8/ The Federal Reserve, in its capacity as the nation's money man-

“ ager, also influences this total through open market operations,
changes in the reserve requirement for member banks. and changes
in the rate at which it lends funds to member banks.

CRS - '20

the government deficit. The mechanism for financing most investment
and government deficits is borrowing (some private investment is fi-

nanced through earnings). The competitive allocation of available funds

a in the money market is determined by the variable interest rate.

The Federal Government finances deficit spending in the same man-
ner as an individual or a corporation; by competing for available funds
in the money market. It is true that the scale of borrowing differs
substantially from that of other borrowers, but the process is similar.
The government must offer an interest rate high enough to make the
securities it offers attractive to potential investors. ‘

l I s .

Traditionally, a supply of funds greater than the demand for funds
should  the interest rate to decline, thereby making some invest-
ments seem more attractive (by making them less expensive) ‘and in-.
creasing money demand. This process should continue until money
demand begins to exceed Supply. Then, interest rates begin to rise
again, discouraging investment and restoring equilibrium between mo-
ney demand and supply. Recently, however, we have been experi-
encing the phenomenon of high interest rates coupled with low demand
for funds. This may be partly explained by the high rate of inflation.
A lender who does not receive an interest ratesequal to or greater
than the rate of inflation will lose money over the term of the loan.

While recession keeps demand for funds low, inflation assures the

maintenance of high interest rates. Additionally, many experts,

CRS - 21

including Federal Reserve Chairman Arthur Burns, have suggested

that certain noneconomic factors, such as public perception of the state
ofthe economy, affect the supply and demand of funds.

The supply of funds “available for investmentdepends on the total
amount saved and the results of the Federal Reserve’s attempts to
regulate the money supply. The amount saved is determined not only
by the interest rate, but by the state of the economy and the savers’
perceptionof it. The demand for funds is most affected by the state
of the economy. Economic growth involves the expansion of invest»
ment, accompanied by a strong; demand for funds to finance it. Con-
versely, conditions  of recession result in a significant drop in invest-
ment. The demand for money falls. I

The Federal Government, borrowirig tofinancre its deficits, is com-
peting with private borrowers who need funds to invest in sursh things

as new housing or productive capacity. A record deficit, caused by

.a serious economic s‘.ixmp, forces the government to borrow un-

precede-nted amounts of money in -a short period of time. The same
slump causes a’ 'decline'i.n demand for funds in the private sector.
With the above discussion as background, the controversy which
arises can bestated as follows: iWill the massive increase in
Federal borrowing occasioned hythe record deficits be offset by an
equal or greater decline in investment in the private sector? Those

who answer this question affirmatively assert that financing the deficit

CR8 - 22%

will not cause serious economic difficulties or threaten the recovery,-'.

Indeed, they see the deficit as performing a crucial role in utilizing  

productive capacity that would otherwise be left unused, thereby aiding
the recovery. -One well-known liberal economist has stated this argu-
ment in the following manner:

t . . . the very forces of rampant recession that make tax and
budgetary stimulus so imperative are the forces that open up a
yawning financial gap for the deficit to fill. The deeper the plunge
of the economy, the greater the shrinkage of private outlets for
savings in the form of corporate borrowing, mortgages, and con-
sumer installment debts. In an economy running $175 billion below
its potential, the deficit will help fill the void, not elbow out private
borrowing. _$}_/ A

Those on the other side of the controversy insist that the drop in
private investment caused by the recession will not be large enough
to offset the record government demand for funds. They foresee, to

II

use the popular term, "crowding out. Private investors with poor

credit ratings, unable to pay the high interest rates caused by the

massive Federal demand for funds, will find themselves unable to ob-

tain the funds they need to undertake investments. Due to their in-

" K
ability to compete with the Federal Government, they will find them-
selves "crowded out" of the financial markets.

An alternative, according to thisview, is for the Federal Reserve

to expand the money supply at an accelerated rate to supply the demand

_S_)_/ Heller, Walter W. Deficit: Where is Thy Stinrj‘? Wil.l Street
Journal, V. 185, March 7, 1975: 10.

CR8 - 23

funds. This procedure could lead to renewed inflation. Seiloman Broth»
ers saw the dilemma this way;

The consequences of a U.S. budget deficit substantially greater

than the nearly $50 billion estimated by us for calendar 19753 shouldi

be clearly recognized. Such a deficit could be reasonably financed
only if the economic contraction this year is much “greater than
we expect. Otherwise the budget defict would either lead to a
vicious struggle for funds between private borrowers and the gov-
ernment, or the Federal Reserve would have to supply funds with-
out regard to its long-range responsibilities. In any event, a larger
than expected deficit. would threaten economic recovery, despit-._‘
the best intentions of government, by crowding out medium to lower

rated borrowers, many of whom are already in peril, and mortgage.

borrowers as well, thus aborting recovery in housing activity. 10/

B. yPicl<ing a Side: Savings Versus Investment
lThe',re is little disagreement over the economic: theories involved
in this"'controversy. l\¢Iost economists agree on the seiverali mechanisms
through which crowding out may occur. llc>wever, theyldiffer as to
which are the most important. Whether or not one believes that crowding
out will be a problem, and when one believes it will occur, depends
on which figures one accepts as representative of savings and invest-
ment ‘to be undertaken this year. i
The Wall Street Journal, for example, esti'nated that in calendar
year 1975, the demand for bo1*rowed funds (projected investment plus
the Federal deficit) would exceed the savings pool (funds available for
borrowing) by  billion. Since the borrowing of the l'<‘cderal Govern-

ment always has first priority, $35 billion in private investment would

_l_()_/ The Wall Street Journal. Crowding Out. v. 185, l\/l£.1I‘(.‘.h 11%,

1975: 16.

CRS - 24

be crowded out. The Journal, while acknowledging that its estimates

may be off to some extent, insisted that the estimate was a conserva-
11/    

'tive one. V

Responiiix,-,g to this anal_vsis,i Mr. Larry Chimerine, manager of
(1.8. Economic Forecasting for IBM, suggested that the Journal's esti~
mate of total private investment in 1975 was much too high. His own

estimate of $176. 4 billion is almost $30 billion below that of the Jour-
12/ a ’

:-—-u-n

nal. Mr. Chimerine's figures, if correct, would mean the effec-
tive elimination of the problem of crowding out, at Least in 1975. Re—
sultingly, interest rates would not rise dramatically and the recovery
would not be threatened.

Croxvrlinggoutis always occurring. As economic conditions c~h:-inge,

some ‘borrowers can -afford to obtain the funds they need, and others

cannot. This is the way» the financial markets function. The ques- ‘

tion in 1975-  whether intensive government borrowing would crowd
outiso many i>o;*rowers as to threaten the recovery. Crowding out

never appeared in a serious way," and Corporate borrowing in the bond
13/

market was in record volume.

i 11/ Ibid.

on-.--onp -un-up-c--..——-w

12/ %The Wall Street Journal. Letters on Deficit l*‘inancin'*. v. 185,
April 2, 1975: 18. ’

13/ Morgan Guaranty Survey. oThe Economy at Yearend-~Review and

Outlook. December 1975. p. 6.

CBS - 25

‘V II. Summary
. """"*-"‘.‘*"*'**“'*

The role of the national debt in public finance is complicated. it
must be viewed from several different perspectives. Looking at the
total amount of the debt, and the cost of supporting it, the economic
problems involved seem manageable. We can afford to support the

current; debt and, if we chose, additional. debt. This is not to support

continued deficit amending, but simply to say that it is economically

cpossible. No serious consequences can be predicted because of the ‘

size of; the debt. There is no apparent or predictable magnitude of
debt  which level difficulties develop.

’i‘1ie effects of financing a deficit in a given year, on.theother hand,
are seriously debated by economists. Recently, this debate has oc-
casioned by the seriousness of the recession. One side sees the def-'
icitas filling the gap in demand left by the decline in private demand
during a recession. The other side fears that financing of the deficit
will result in significant crowding out, which in and of itself is seen
as a potentially serious blow to economic recovery. The mechanism
by which crowding out occurs is one that most economists agree upon.
The perception of the seriousness of the problem depends upon one's
vievv of the solution of the economy.   i

Due to the polarismtion of these two viewpoints in 1975, the issue
became clouded, with one side warning of dire consequences and the

other being optimistic on the effects of the deficit. The adoption of a

CRS ~ 25p

middle ground between these two positions provides a more reasonable

perspective. Crowding out is the normaltprocess through which funds

are allocated in the money markets. Itis not; process which has
suddenly materialized this year‘ because of economic conditions as the
publicity it has received might lead one to believe. ln fact, crowding
out did not occur in any important" way in 1975. V Nevertheless,- it is
a continuing and significant phenomenon, and merits attention.

Over the years, the traditional arguments condemning government
spending and all forms ofdebt have been eroded by a changing economic
structure and the development of economic theory. Debt has become
an integral, and necessary, mechanism in the functioning of our eco-i
nomy._ Yetthis need not indicate that continually expanding tgovern-
ment (or private) debt is good. Since 1931, only seven Federal bud-
getsihaveshown surpluses. Most of increases in the national debt.
have resulted "by.accident" rather than by formulated policy. While
thisvtrendnced not be seen as giving rise directly to economic difficu1..
ties, it is disturbing in anothersense. The growth of our national

debt may be seen as a syrnptcm ofuour inability to control the expen-

A ditures of the Federal Government. Given the working interrelation~

ship between the economy and the government, this is a problem to
be considered seriously. Fven if the national debt does represent a
serious problem, or is symptomatic of one, it will_not be solvedby

quick fix or simple solutions. The ultimate question concerns the role

ans-27.

of the Federal Government inour economy, and‘ it is from that point

of View that the national debt shall be viewed.

dd

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