Deficit Spending and Government Debt

Deficit Spending and Government Debt

Deficit spending means spending in excess of tax revenues. The
Treasury recovers all such spending on average by the sale of its own
securities. In the long run, too little recovery would result in
excessive liquidity in the private sector and create inflationary
pressures, while too much would result in a liquidity squeeze.

It is evident then that a balanced reciprocal flow of funds between
the Treasury and the private sector is essential in controlling the
financial health of the economy. That is true regardless of the total
amount of Treasury debt outstanding. The question naturally arises --
can the Treasury always sell its debt securities to cover its deficit
spending?

The answer is ?yes.? Say the Treasury needs $10 billion by the end of
the month to cover its deficit spending. It announces an auction for
$10 billion of its securities to be sold at or before the end of the
month. The auction participants, mainly large financial firms such as
banks and securities dealers, bid competitively on a yield basis.
That is, they state the yield and the dollar amount they will commit
at that yield.

Since dollars earn no interest, there will always be a yield at which
those with more dollars than they need will be willing to purchase
interest-earning Treasury securities. The Treasury can always meet
whatever yield the market demands. The successful bidders in this
example are those who bid the lowest yields and whose combined bids
total $10 billion. All of the accepted bidders receive the same
yield, corresponding to the highest yield bid of the group. Bidders
seeking a higher yield are rejected.

The Treasury need never default on its outstanding debt. If Federal
tax revenues are insufficient, it can always sell new debt to the
public to cover its maturing debt as well as new deficit spending. If
necessary, the Treasury could borrow directly from the Fed. However
that option is rarely used and only if needed to cover a temporary
shortage of funds. Normally the Treasury holds sufficient reserves in
commercial bank accounts to bridge the gap between receipts and
spending.

William F Hummel
.

Relevant Pages

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