At the end of 1999 the federal debt held by the public amounted to $3,633 billion, or about $15,000 for every man, woman, and child in the population. We will be hearing a lot of big numbers like that during the presidential election campaign, because Mr. Gore has said that if he is elected a principal goal of his administration would be the reduction of the debt, all the way to zero. Mr. Bush, characteristically, hasn’t said much about the debt. The Republican members of Congress have spoken favorably of debt reduction, but his and their preference for large-scale tax relief must mean that the fate of the public debt is not their highest priority. Tax reduction and debt reduction are at odds arithmetically; they compete as alternative uses of any given budget surplus. And, as will be seen, they imply quite different priorities about the right way for the economy to use its productive capacity.
My goal here is to describe how the public debt arises and evolves, and how and why its size matters for the functioning of the national economy. That will not tell you the correct policy for here and now or for next year, but it’s a start.
Every year the federal government makes expenditures. Some of them are specified in detail in the budget, others are determined by legislated formula, although the exact amount spent depends on the number of people who retire, get sick, or become unemployed, and on many other contingencies. The government also collects tax revenues. Again only a formula is legislated in the form of tax rates. The exact amount collected is always uncertain because it depends on economic events: wages and profits earned, goods imported, airline tickets bought, for example. (There are other, more complicated, aspects of budgetary finance that I pass over here.)
Suppose that outlays exceed revenues; there is then a budget deficit. The Treasury has to pay its bills. It could run down its bank account, like anyone else, but that wouldn’t cover much of a deficit or last very long. The Treasury then has two options. One is loosely described as “printing money.” The process is actually more complicated than that, but in the end the deficit is financed by an increase in the stock of money. The other way is to borrow the necessary funds by selling bonds to the public. The Treasury pays interest regularly and then, when bonds issued in the past come due, the Treasury has to deliver the face value; it usually gets the funds by selling new bonds in roughly the same amount, often to the very holders of the maturing debt. So the debt rises when there is a series of budget deficits. When there is a series of budget surpluses the debt will fall; the Treasury can use its spare cash either to buy back outstanding bonds in the market or to pay off the principal of maturing bonds without issuing …