The government debt problem involves a wide range of influences, such as fiscal sustainability and macroeconomic stability. It is a major issue that the government needs to research the macro management. Although the developed economies have set up some artificial fiscal rules, for example the United States set a debt ceiling, they have not prevented the expansion of their debt levels. Government debt has never been as high as it is today. At the end of 2014, US government debt reached 85.5% of the annual GDP (Mankiw, 2016, pp.557). The size of US government debt is the highest in the world. In the face of rising government debt, more and more people are beginning to be skeptical, while others believe that government debt has brought benefits to the country. This article will explain some key reasons behind the rising government debt in the second section before elaborating on different perspectives of government debt through relevant theoretical knowledge. On the basis of these analyses, this paper then makes critical thinking about the government debt.
2. The Reasons behind the Rising Government Debt
Historically, countries have been more cautious about the expansion of government debt. In the early days of the founding of the United States, Congress examined the amount, duration, and interest of each government debt. Even today, Congress still determines the upper limit of government debt. Therefore, the reasons why the government debt of countries in the world, especially the developed economies, is expanding to such a high level and continue to expand are worth researching. There are different reasons for government debt in different historical contexts.
2.1 Government Debt for War
In history, Western countries were more inclined to use the two methods, tax increase and government debt issue, to raise funds for war. It gradually developed into a fund-raising method based on government debt (Ohanian, 1997). Adam Smith (1817) pointed out in his book, An Inquiry into the Nature and Causes of the Wealth, that if a government did not save money in peacetime, it would have to borrow in wartime. Because once the war broke out, there was going to be a big expense. If the government increased the tax in a large amount to support the war, it would hurt the feelings of the people and made them hate war. On the other hand, the cost of war was uncertain, and it was more difficult to determine how much tax should be increased. More importantly, spending was imminent, and taxation took a long time and was difficult to raise in a short period of time. Debt can easily solve these difficulties. Moreover, if the government foresaw that it was easy to borrow, the government would not try to save it, and borrowing would happen more frequently. Thus, borrowing was not only used to raise funds for war, but also to raise funds for other urgent needs or unexpected needs such as disasters.
In order to cope with government debts such as wars and other unexpected events, the debt level should gradually fall after the war. The ratio of Government debt to GDP since 1791 of the U.S can indeed identify a war cycle in which debt levels rise and fall (Mankiw, 2018, pp.558). However, this decline in debt levels mainly refers to the ratio of total government debt to GDP, rather than the nominal amount of government debt. The mainly reason for the decline in government debt levels after the war was that economic growth and inflation caused the original government debt size to become smaller relative to the overall economic scale, rather than the debt scale itself becoming smaller (Bohn, 1998). Obviously, the war cycle theory of debt cannot explain the rising nominal amount of government debt and the proportion of relative GDP in the world’s advanced economies, especially the fact that the rise in debt mostly occurs in peacetime without war.
2.2 Welfare State
One of the reasons for the rising Government Debt during the peacetime without war is related with the nation’s welfare. In the 1970s and 1980s when Keynesianism faded, the level of government debt in developed economies began to rise. The government debt at the time was not intended to maintain macro stability, but rather to maintain the idea of a welfare state. After World War II, Western countries introduced social security systems that included pension, medical care, unemployment assistance, and transfer payments to the poor. During the post-war recovery and reconstruction period, the economies of the western countries grew rapidly. Even when the tax rate increased, people would not grow dissatisfaction. Therefore, the fiscal deficit grew rapidly and could cover ambitious social security plans. However, after the two oil crises, the economic growth rate of the western countries declined, and the fiscal deficit growth slowed down. But at that time, the residents in various countries regarded the enjoyment of state welfare as a natural right. They did not allow the reduction of welfare levels, and even expected to continuously improve the welfare standards (Bohn, 1988). At the same time, life extension, increased structural unemployment, and rising actual medical costs were also increasing social security spending. As a result, Western countries not only experienced fiscal deficits during the economic downturn, but also had fiscal deficits when the economy was at a potential output level or even when the economy was booming. Such a deficit was no longer a cyclical deficit, but a structural deficit. Structural deficits can lead to rising government debt levels (Coricelli & Ercolani, 2002). High welfare will strengthen itself and continue to push up debt levels. Excessive welfare can lead to low productivity, low economic growth and high unemployment. The lower the growth and the higher unemployment, the higher the need for high welfare to maintain social stability. It can be said that these problems solved with welfare are themselves brought about by welfare. These countries were unable to maintain high social security spending by further raising taxes, as taxes will further damage economic growth and bring more unemployment and welfare spending. So they can only maintain the functioning of the welfare state by raising government debt (Floden, 2001).
3. Various Perspectives of Government Debt
Government debt refers to the debts that the government borrows from foreign governments and banks or the bonds issued at home and abroad (Elmendorf & Mankiw, 1999). The government relies on its credibility as a way of credit to raise financial funds between the debtor and the creditor in accordance with the principle of compensation. Government debt is a special distribution method in which the government allocates social funds, compensates for fiscal deficits, and regulates economic operations. Government debt is an important part of the overall social debt. In terms of government debt, the main points of view are Keynesianism and Ricardoism. These two theories put forward opposing views on the government debt and the impacts of the government debt on residents’ consumption.
3.1 Keynesian View of Government Debt
According to the Keynesian theory on the government debt, many consumers are liquidity- constrained and myopic in the economy. The aggregate consumption is sensitive to any change in current income which is disposable. Temporary cuts in tax increase government debts, which makes people feel the increase in disposable income in the current period, thereby stimulating private consumption and increasing aggregate demand (Mankiw, 2016, pp.564-566). For example, Modigliani (1963) thought that the private sector regarded government debts as the net wealth. As government debt issuance increases and the net wealth of the private sector increases, its willingness to spend will increase.
Keynesian theory holds that although the debt expenditure can make the society rich. Therefore, the government debt is encouraged at appropriate level (Rangarajan ; Srivastava, 2005). After the Great Depression of the 1930s and the rise of Keynesianism, government debt had a new function. In the period of insufficient total demand, the government increased the fiscal expenditure by issuing bonds, used the deficit fiscal method to stimulate demand growth, and achieved full employments. This theory constitutes the ideological basis of functional finance. Functional finance means that the government’s fiscal budget is not to achieve fiscal balance, but to have the function of adjusting surpluses and deficits to achieve price stability and full employment (Colander, 2002). Keynes’s theoretical and functional financial thinking broke the traditional fiscal discipline that the government must maintain fiscal balance, giving the government another reason to expand its debt. To finance the war, the government was forced to indebted. During the recession or depression, the government expanded its debt by expanding its total demand through deficit finance (Alesina ; Tabellini, 1990). This functional financial idea is very different from the use of debt in the past. However, there is a similarity of war cycles between the functional fiscal and debt. The expansion and contraction of debt should be cyclical and it should expand during periods of economic recession and depression, and gradually shrink during periods of recovery and prosperity (Alesina ; Tabellini, 1990). Keynesianism believes that effective demand is not enough to lead to economic recession. In order to stimulate economic prosperity, deficit finance must be implemented, which will inevitably generate debt.
3.2 The Ricardian View of Government Debt
However, other economists believe that people are not so myopic. Beginning in the 1970s, Keynesianism gradually subsided, and monetarism and rational expectations schools emerged one after another. The effects of fiscal policy were gradually suspected, and their shortcomings began to be recognized. For example, residents and businesses may realize that today’s fiscal deficit and increased government debt mean future tax increases. The increase in government debt means that in the future, the burden of government repaying the principal and interest will also increase, and people’s tax burden will increase accordingly. Therefore, rational individuals will weigh this adverse effect. In order to smooth consumption, they would not choose to spend more during the fiscal expansion period, but choose to have more savings to cope with the decline in income caused by future tax increases. This will offset the stimulating effect of fiscal expansion on aggregate demand. Government debt can only be considered a net wealth when the government debt held by people surpasses the discounted value of the corresponding tax burdens in the future. The government debt increase will have an effect on the people’s savings behaviors and aggregate consumption. This effect is called the Ricardian equivalence. The key points of Ricardian equivalence is that government debt is only a delay in taxation. The current national debt to make up for the fiscal deficit is bound to be compensated by means of taxation in the future. Consumers are farsighted. They know that tax cuts for fundraising today mean higher taxes in the future. The present value of future tax will equals to the current fiscal deficit (Mankiw, 2016, pp.567-569). The far-looking residents can realize that the government will increase the debt pressure in the future by increasing taxes or continuing inflation, such as tax levy. The increase in taxes will reduce the residents’ future income and personal permanent income. Therefore, tax cuts will not make consumers rich, and they cannot increase consumption. The most selective choice for residents is to increase labor supply and reduce consumption. They will save all the tax cuts to pay for future tax liabilities. The result is that private savings increase public savings, while national savings do not (Mankiw, 2016, pp.567-569). Government borrowing has no contribution to economic development, but it has higher risks. Therefore, Ricardo opposed government debt.
3.3 Other perspectives on Government Debt
In addition to the above two views on government debt, some economists oppose the mechanical balance of the budget and promote the optimal fiscal policy. There are several advantages of the fiscal policy. First, the optimal fiscal policy can stabilize the economy (Mankiw, 2018, pp.572). During the recession period, the government needs to raise taxes or reduce spending if it implements the budget balancing policy. Such a policy will further suppress aggregate demand. Second, the optimal fiscal policy can help reduce the distortionary incentives caused by the tax system (Mankiw, 2018, pp.572). High taxes can hinder economic activity. For example, high taxes can lead people to reduce working hours. Therefore, the government will use the deficit to maintain the relative stability of the tax if there are high tax rates on labor earnings. Third, the optimal fiscal policy can coordinate the tax pressure within the current and future generation. For example, during the war, the government expanded its debts to support its activities, thus increasing fiscal deficits. The government can pay off this debt throng taxing the next generation.
4. Critical Thinking on Government Debt
Based on the above theory, it is suggested to comprehensively analyze the advantages and disadvantages of increasing government debt. The answers of this problem can be based on different aspects, including the government debt of the short-term and long-term, and the government debt in small amounts and large amounts. From the aspect of time period, if the government increase the short-term government debt that is used to increase government spending or reduce government tax revenues to deal with economic recession, it is beneficial to the increase of the production value and employment (Samuelson ; Nordhaus, 1992). In addition, in terms of quantity, if the government debt is small, it will have a regulatory effect on social demand without adverse effects. However, in the long run, huge government debt has a negative impact on the economy (Samuelson ; Nordhaus, 1992). The main drawbacks are the followings. First, the increase in government debt means an increase in demand for money market funds, which leads to an increase in interest rates. The rise in interest rates has two negative consequences. One is to reduce investment through the extrusion effect. The other is the appreciation of the currency exchange rate through capital inflows, which has further adverse effects on foreign trade (Samuelson ; Nordhaus, 1992). Second, the increase in government debt ultimately depends on increasing taxes to repay. Even if the same person is taxed to pay his government debt rate, it will lead to distortion of the incentive mechanism. People will reduce savings due to the holdings of the government debt and reduce their work as taxes increase. Third, the increase in government internal debt means that people hold more government bonds other than corporate stocks and corporate bonds, thus creating a situation in which private capital stock is replaced by government debt (Samuelson ; Nordhaus, 1992). Fifth, once the government fails to repay the principal and interest of the debt on time, its credit rating will fall and its financing costs will rise. In addition, its debt instruments will depreciate, and financial markets will be volatile (D’Erasmo, 2008). Sixth, once the government fails to repay the principal and interest of the debt on time, it will not only have a strong contractile impact on the economy, but it will also lead to social unrest because of the decline in social welfare if the government chooses to reduce government spending and increase government taxation to reduce the debt burden. If the government chooses to issue money to reduce the debt burden, hyperinflation will occur. Government debt can play a positive role in the country’s economic operation, but it is also suggested that the government prevent the government debt from being too high, which will definitely have a negative impact on the economy.
Government debt has attracted a great attention not only in academic research, but also in the media and the public. As the government’s intervention in the economy has increased, the deficit has continued to appear and government debt has continued to increase. There is still no unified conclusion about the effects the government debt has on economic growth. From the government debt harm theory that government debt erodes social productive capital and thus affects economic development, to the debt neutral theory based on Ricardo’s equivalence theorem, and later the theory of Keynesian that emphasis on government debt to economic growth role, the researchers analyze the government debt and interpret the internal relationship between government debt and economic growth from different perspectives. The constant high levels of government debt have different reasons in different historical periods. Moreover, government debt can also have a positive effect on the economy. However, the high level of government debt can lead to economic crisis. The decline in the US government debt rating caused the erupt of the US government debt problem, leading to people’s thinking about the fiscal deficit. Under the influence of their respective fiscal deficits, the US administrations have continuously created records of government debt, which has brought serious hidden dangers to the US economy and the world economy. In the case of a government debt crisis in many countries around the world, it is time to re-adjust the fiscal deficit concept and countries should be wary of excessive government debt, which will have a negative impact on the country and society.
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