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Economics U$A: 21st Century Edition

Federal Deficits (Macroeconomics)

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During WWII, our national debt had more than quadrupled, so government encouraged citizens to buy war bonds and federal stamps to pay some of it off. In 1960 President Eisenhower achieved a surplus and reduced the debt, a feat not repeated until the 1990s. But a large tax cut in 2001, three wars, a down market and huge entitlement costs pushed the deficit and the national debt to an alarming new height that forced a fierce confrontation between Congressional Democrats and Republicans. These stories show that deficits can be helpful or harmful, but long-term debt is serious business.

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Unit Overview

Purpose:

To show that deficits can be helpful or harmful, depending on the circumstances.

Objectives:

  1. Deficits can rise not only because policy makers raise spending or lower taxes, but also when the economy is in a recession. During recessions, unemployment benefits and welfare payments rise automatically while tax receipts drop. One way to separate the cyclical and structural components of the deficit is to estimate what the deficit would be if the economy were operating at full employment.
  2. In the short run, deficits can have two potentially damaging effects on the economy. First, if the economy is at full employment, a government deficit is inflationary, because the excess of government spending over government revenues adds to aggregate demand pressures in the economy. Second, to the extent that federal deficits raise interest rates, they can retard growth in investment and housing activities, which are interest-sensitive.
  3. In the long run, deficits can be harmful if they add to the debt burden. Persistent deficits mean a rising national debt. If the national debt rises fast than GDP/GNP, then this can have serious negative ramifications for the future growth potential of the U.S. Moreover, if a large portion of the debt is held by other countries, then this means that foreigners have a large claim on U.S. resources.
  4. Government budgets should not necessarily be balanced at all times. Specifically, in a recession, balancing the budget means cutting spending and/or raising taxes—both of which have a contractionary effect on GDP/GNP. Nevertheless, in the long run the structural deficit (as measured by the full-employment deficit, for example) should be close to zero.
  5. It is important to distinguish between balancing the budget and reducing the size of the government. A large government can have a balanced budget while a small government can run a large deficit.

Meet the Series Experts

Alice Rivlin

Senior Fellow at the Brookings Institution and Member of President Barack Obama’s 2010 Federal Debt Commission, known for her expertise on fiscal and monetary policy. She was Director of the Congressional Budget Office, Director of the Office of Management and Budget, and Vice Chair of the Federal Reserve Board, 1996–1999. She also served as Chair of the District of Columbia Financial Management Assistance Authority and Welfare Assistant Secretary for Planning and Evaluation at the Department of Health, Education, and Welfare. She received a MacArthur Foundation Fellowship, has taught at Harvard University, George Mason University, and New School University, and has served as President of the American Economic Association. She is a frequent contributor to newspapers, television, and radio and has written many books, including Systematic Thinking for Social Action, Reviving the American Dream, and Beyond the Dot.coms (with Robert Litan). Dr. Rivlin received her B.A. from Bryn Mawr College and Ph.D. in Economics from Radcliffe College (Harvard University).

Alan Simpson

U.S. Senator from Wyoming, 1979–1997, and Co-Chair of President Barack Obama’s 2010 National Commission on Fiscal Responsibility and Reform. A Republican opponent of government regulation, he has at the same time defended women’s “right to choose,” gay and lesbian rights, and equality for all persons regardless of race, color, creed, gender, or sexual orientation. He was Republican whip, 1985–1995, and Chairman of the Veterans’ Affairs Committee, 1981–1987 and 1995–1997. He also chaired the Immigration and Refugee Subcommittee of the Judiciary Committee, the Nuclear Regulation Subcommittee, the Social Security Subcommittee, and the Committee on Aging. After retiring from politics, he taught at Harvard University’s John F. Kennedy School of Government, serving two years as Director of the Institute of Politics, then returned to Wyoming to practice law. Senator Simpson received his B.A. and J.D. from the University of Wyoming.

Charles L. Schultze

Public policy analyst and Senior Fellow Emeritus of the Economic Studies Program at the Brookings Institution since 1977. Earlier he served as Associate Director and Director of the United States Bureau of the Budget under Presidents John F. Kennedy and Lyndon B. Johnson, and was Chairman of President Jimmy Carter’s Council of Economic Advisers, 1977–1980. He was also President of the American Economic Association and Member of the Economic Advisory Board at Warburg Pincus LLC. He has taught economics at the University of Maryland and at Indiana University. Dr. Schultze received his B.A. and M.A. from Georgetown University and Ph.D. in Economics from the University of Maryland.

Raymond Saulnier

Chairman of the Council of Economic Advisers (CEA) under President Dwight D. Eisenhower. Earlier, he was the Director of the Financial Research Program at the National Bureau of Economic Research, where he invoked the usage of government-developed “economic indicators” (statistics about the economy). While at the CEA, he co-wrote a brief that led to the termination of the 1959 steel industry strike held by the United Steelworkers of America. From 1944 to 1973, he was also a professor at Columbia University/Barnard College. He wrote three books, including Contemporary Monetary Theory. His articles were published in The Conservative Papers, The Republican Papers, and Fortune magazine, and by several university presses. Dr. Saulnier received his B.A. from Middlebury College, M.A. from Tufts University, and Ph.D. in Economics from Columbia University.

What's your Economics IQ?

Take the Economics USA: Federal Deficits Quiz.

Quiz Addendum

1. Answer Explanation:
Inflation may be relieved somewhat, but unemployment will be seriously aggravated. During a recession, balancing the budget will mean cutting spending and/or raising taxes, both of which will have negative effects on GNP and employment levels.

Glossary

  • cyclically balanced budget
    Refers to running a surplus in boom years and a deficit in lean years; in theory the two offset each other over time.
  • debt-to-GDP ratio
    A measure of a country’s federal debt relative to its gross domestic product (GDP); one measure of a country’s ability to pay back its debt.
  • external debt
    Part of the total debt in a country that is owed to creditors outside the country.
  • fiscal dividend
    The increase in federal revenues that accompanies economic growth; sometimes argued to follow as a benefit from reduced taxation and increased government expenditures.
  • fiscal drag
    Acts as a damper on the economy when, during inflation, rising incomes draw people into higher tax brackets, so that the purchasing power of their disposable incomes falls.
  • full employment
    The minimum level of joblessness that the economy could achieve without undesirably high inflation, recognizing that there will always be some frictional and structural unemployment.
  • internal debt
    That part of a country’s total debt that is owed to lenders within that country.
  • public debt
    The total financial obligations incurred by all governmental bodies of a nation; the national debt. At the federal level, part of the national debt is held by members of the public and part by agencies within the government.
  • size of the deficit vs size of the government
    A notion referring to the tendency of some to assess the size of government with the size of the deficit.

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Credits

Produced by the Educational Film Center. 2012.
  • Closed Captioning
  • ISBN: 1-57680-895-5