Public Debt in Managing Macroeconomics

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Public debt is beneficial when maintained at low levels against the GDP. When the public debt goes beyond 85% of the GDP, it starts to become a burden.

Public debt is useful in managing macroeconomics through fiscal policy. It allows governments to form stable tax rates without the influence of market fluctuations. It reduces present taxes but increases the ones in the future.

The impact of public debt is reduced when it used in key areas that will increase future productivity such as human capital. Deficit financing may result in growth that provides a surplus. The surplus may be used to service the debt eliminating inflationary effects.

High public debt reduces government’s ability to borrow. This limits the ability to use expansionary fiscal policy to stimulate economy growth. The government may find it necessary to increase interest rates to attract creditors.

With high interest rates, debt servicing becomes more costly. The rates compound, and finally the government’s ability to repay the debt is doubted. An example is China, the main creditor to USA, doubting USA’s ability to repay loans. Without lending, consumption and investment would decline.

The additional debt may be considered to have a crowding-out effect on capital accumulation. The Greece case shows an economy that additional capital was no longer producing growth. This is when additional capital has diminishing returns.

Further concerns about high public debt is the accumulating fraction of those who are aging in the population. With a high dependency ratio, it becomes difficult for a government to take care of social services, and a high public debt.

Causes and Solutions to the Debt Crisis

The US debt crisis is considered to have been caused by tax cuts, stimulus packages, and the Iraq/Afghanistan wars. Availability of credit at low interest rates is considered to have caused consumption to rely mostly on debts. As a result of cheap credit, financial assets exceed GDP several times.

The Greece debt crisis is considered to have been caused by tax cuts/evasions, generous pensions, expenditure on the 2004 Olympic Games, health care benefits, and reliance on tourism and shipping industries.

The Greeks took lots of debts because their economy was growing at a very high rate before the global recession. Similarly, they borrowed to invest in real estates. However, all these causes are blamed on bad governance.

The Federal government has plans to reduce spending while the Congress wants to raise the debt ceiling to avoid defaulting. The Congressional plan will give the economy more time to fix the problem.

The Federal government plan is more effective. The Fed plan is more effective because it reinstates confidence which affects financial markets. The solution to the US’ debt crisis is to reduce government spending.

Socialism is not portrayed by the government owning big companies. This is because they are run in a capitalist manner. The government sets funds for stability. It hires a CEO who runs it for profit maximization.

This is similar to private business. In socialism, the main aim is to increase utility to citizens. In that case, it would make them have quality products at the lowest price even when there is an opportunity to charge higher prices.

It was necessary for the government to bail out these companies to prevent the economy from going deeper into recession. When the big companies run out of business, a big workforce is laid off. Consumption decreases, and other companies soon experience the declining purchasing power. They react by reducing workforce, and overall expenditure.

Developing Economies and Middle Classes

There are many obstacles to economic growth in developing countries. The main ones include political instability, inefficient human capital, dual economy, and lack of investment.

Political instability discourages capital inflow causing lack of investment. Inadequate savings are caused by low per capita income. This makes the countries to be locked in the vicious poverty cycle.

Developed countries can assist these countries by ensuring they have stable democratic governments. They can assist by transferring human capital or technology to these countries.

There is no crowding-out effect in these countries, so capital inflows will generate higher output than additional capital accumulation in developed countries. This is a benefit to external investors as well as the developing countries.

A stable economy relies on a high domestic demand. The middle class is the main contributor to domestic demand. This is because they have purchasing power, and they demand consumer goods. The upper class are few, and most likely to demand capital goods.

The lower class lacks purchasing power. The US economy is considered to be shrinking because the middle class size is declining. For a sustainable economy, the middle class should be bigger in size.

A middle class is created by progressive tax rates. In the US case, tax cuts seem to have benefitted more the upper class than other classes. A middle class can be expanded by raising taxes on the upper class, reducing taxes on the middle class, and tax exemption for the lower class.

Increasing government expenditure to finance tax cuts for the upper classes has not done well in the US economy. There is need to create a balance to avoid relying on deficit to fund government spending.

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Public Debt in Managing Macroeconomics

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