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National Debt

The debt held by the government of a country

What is National Debt?

National debt refers the debt held by the government of a country. It can also include the debt held by a province of a country or even a municipality.

 

National Debt

 

Classification of National Debt

National debt can be classified in various ways, such as listed below:

 

1. Issuer

National debt can be issued by different levels of government from federal to municipal. The risk profile of the debt depends on the issuer. Municipal and provincial debt is deemed riskier than federal debt.

 

2. Maturity

Just like other kinds of debt, national debt also has different tenors. Most national debt is long-dated, and typically the yield on 10-year federal government bonds is considered the prevailing risk-free rate.

 

3. Method of Repayment

The method of payment refers to the source from which repayment is derived. Typically, taxes are used to repay government debt, but repayments can be derived from a specific source, such as tolls, if the debt is used for the construction of a highway.

 

4. Holder

National debt can be held either by citizens or foreigners. The debt held by citizens is in the local currency, while the debt held by foreigners is typically in the foreign currency. Any government exerts more control over the local currency; hence, the risk of default is much lower for the debt held by citizens.

 

Debt vs. Deficit

National debt should not be confused with deficits. A deficit is created, when in a year, the expenditure of the government exceeds its revenues. To fund the deficit, the government may issue debt, sell assets, or raise taxes. Hence, the deficit is not equal to debt, but it adds to the national debt if financed by debt.

 

Instruments and Mechanics of National Debt

 

Instruments

National debt is issued mainly through two instruments:

 

1. Bonds

Government bonds are issued in the local currency by the central bank of the country. The government borrows money from the central bank, and then the central bank auctions these bonds to the public via selected financial institutions. These bonds are tradeable and have a liquid market. Common examples of government bonds are the U.S. Treasury Bills, British Gilts, German Bunds, Japanese Government Bonds (JGBs), etc.

 

2. Loans

Governments can also raise funds via loans from commercial banks. These are syndicated loans extended to national governments. Unlike bonds, they are not tradeable, but there might be derivative instruments – like credit default swaps – linked to the performance of these loans.

 

Mechanics

There are clear procedures laid down for the settlement of government debt. The Bank for International Statements (BIS) is the international body that makes the rules and administers the settlement of national debt. In the case of a default, the rules are not clearly defined. They are dealt with using laws of default pertaining to specific countries.

Typically, national debt is restructured, and some restrictions are placed on government expenditure. The main reason behind restructuring is that the government must continue to function even if it cannot service its debt.

 

Economic Policy Consequences

The use of national debt comes with consequences for economic policymaking. Two arguments define the impact of national debt on the economy and whether it should be used:

 

1. Ricardian Equivalence

Ricardian equivalence refers to the equivalence in the use of debt or taxes to meet the financing needs of the government. The argument is as follows – if the people know that using debt today will translate to more taxes in the future, then there is no difference in using debt or taxes.

The policy assumes that the use of debt is the same as taxes. The problem here is that the degree to which people realized the fact is unknown and hence, the equivalence cannot be used to decide the mix between debt and taxes.

 

2. Crowding Out Effect

The crowding out effect is the impact of increased government spending using debt. The argument is as follows – when the government issues more debt, it takes up monetary resources that could’ve been used for private investment.

The practice increases the interest rate for other borrowers, and hence, reduces the investment done by the private sector. It runs counter to the idea that government spending can be used to stimulate and grow the economy. Therefore, there is a possibility that the use of debt can harm the economy.

 

National Debt Measures and Statistics

There are various measures of national debt that are reported by organizations like the International Monetary Finance (IMF) and the Federal Reserve. Some examples of the measures used for national debt are:

  • Central Government Debt: The stock of debt issued by the central government of a country. It is reported either as an absolute amount or as a percentage of GDP.
  • General Government Debt: The stock of debt issued by all levels of government in a country, which includes provincial and municipal debt.
  • Non-Financial Public Sector Debt: The amount of debt that non-financial public sector corporations hold. The debt is often guaranteed or considered to be guaranteed by the government.
  • Financial Public Sector Debt: The amount of debt issued by government-owned financial institutions like public sector banks.

 

The following map is based on IMF data on public debt held by various counties as a percentage of GDP:

 

Debt-to-GDP Ratio
Source

 

Additional Resources

CFI is the official provider of the Certified Banking & Credit Analyst (CBCA)™ certification program, designed to transform anyone into a world-class financial analyst.

In order to help you become a world-class financial analyst and advance your career to your fullest potential, these additional resources will be very helpful:

  • Balance of Trade
  • Happiness Economics
  • Budget Deficit
  • Default Risk

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