3.3.3 3.3.4 SUSTAINABLE DEBT 3.3.5

GOVERNMENT DEBT refers to the amount of money that the government owes to its lenders.

• If GOVERNMENT SPENDING > TAX REVENUE, the government is said to be 'RUNNING A BUDGET DEFICIT', which is usually FINANCED BY BORROWING.

• BUDGET DEFICIT => INCREASES GOV'T DEBT. 

• BUDGET SURPLUSES => DECREASES IN GOV'T DEBT.

• As long as the government collects enough revenue to pay its interest payments and part of its principal then the debt is referred to as SUSTAINABLE DEBT. 

The main tool used by the government to raise money, are GOVERNMENT BONDS, which are DEBT CERTIFICATES that the Government gives to lenders with the promise to pay them back the PRINCIPAL AMOUNT plus INTEREST at some date in the future.

--CREATES OPPORTUNITY COSTS--

• All debt repayments DIVERT LIMITED GOVERNMENT TAX REVENUE away from government spending commitments such as health and educational services

• In addition, funds borrowed from overseas must be repaid in foreign currency which DIVERTS LIMITED FOREIGN EXCHANGE RESERVES away, which could have been used to import important capital goods.

• A HIGH DEBT to GDP %, means that a country may have DIFFICULTY PAYING BACK its loans, hence it MAY receive a LOW CREDIT RATING.

• WHAT DOES THIS MEAN?, This means that the country will find it difficult to secure future borrowing, plus if they do, the interest rate will be much higher in order to compensate the lender for the higher risk.

• In order to REDUCE HIGH DEBT the government will NEED TO RUN BUDGET SURPLUSES.

• This can be achieved through HIGHER TAXES and/or CUTS IN GOV'T SPENDING, both of which are UNPOPULAR.

• BOTH LEAD TO A FALL IN AD, creating a RECESSIONARY GAP, LOWERING 'C' and 'I'.

• In a recessionary gap, CYCLICAL UNEMPLOYMENT OCCURS...

• FALL IN INCOME TAX REVENUE + HIGHER GOV'T SPENDING ON UNEMPLOYMENT, and OTHER WELFARE  => EVEN LARGER DEFICIT.

• so what now? Even higher taxes, even less spending?, but this will mean less GDP, which means less tax revenue and more spending on benefits....oh dear!!

As mentioned when the DEBT-TO-GDP ratio is HIGH,  the potential for economic downturns increases which in turn deters investment as LONG-TERM RETURNS will be UNCERTAIN.

A HIGH LEVEL OF DEBT financed by foreign borrowing may have involved making economic and political concessions