The most recent crisis of skyrocketing budget deficit and the public debt of the
ID: 1230740 • Letter: T
Question
The most recent crisis of skyrocketing budget deficit and the public debt of the US government has been the source of continuous economic uncertainty in the recovery process of the Great Recession of 2008. Such uncertainty and the fear of potential default of paying the US debt installments have led the credit agency S&P 500 to downgrade the US bond ratings from AAA status to AA+ for the first time in US history.From your understanding about the theories and applications of bond market in this class, critically but briefly analyze the reasons why the effect of the downgrade of US Treasury bond ratings on interest rates was not the way one would predict from the basic theories of the bond market. In another words, critically analyze the reasons why the short term yield and interest rates did not increase after the downgrade of US Treasury securities by S&P 500.
Explanation / Answer
While budget deficits are nothing new for the U.S., the size of this year’s deficit looks to hit a new record, according to the Congressional Budget Office (CBO), a nonpartisan budget agency. New budget estimates predict the government’s deficit will reach almost $1.5 trillion in 2011, surpassing the last record of $1.4 trillion set in 2009. Government spending has been skyrocketing at a time when revenues have cratered. The latest figures reflect an outsized bill for significant outlays as part of government bailouts and stimulus spending. The revenue side of the ledger is still quite daunting. As a share of the economy, tax revenues in 2011 are projected to reach their lowest levels since 1950. The CBO projects tax revenues lower than in 2009. Even with projected increases for 2011, revenues will not keep pace with the growth in spending. With the exception of a brief five year period in the late 1990s, the U.S. ledger has been in a deficit mode for more than 40 years. Today’s sobering numbers mean that the government is borrowing 40 cents for every dollar it spends. Like us on Facebook Coming just one day after the President’s State of the Union address, these new figures put a heightened level of urgency to a debate that is growing in Congress over spending. Looming large on the legislative calendar for this session is a bill to raise the $14.3 trillion cap on the deficit set by law. In a politically divided Congress, there is significant disagreement on where any spending cuts should be made and how much. A new government funding bill that comes up for a vote in February will be a flashpoint for this debate. The CBO analysis predicts the economy will grow by 3.1 percent this year, but that joblessness will remain above 9 percent. Some states such as California don’t expect to see unemployment fall below 10% in 2011. The CBO estimates a nationwide unemployment rate of 8.2 percent on Election Day in 2012. “The fiscal challenge confronting us is enormous. To solve this problem, it will require real compromise and a great deal of political will,” said Budget Committee Chairman Kent Conrad, D-N.D. “We need to have both sides, Democrats and Republicans, willing to move off their fixed positions and find common ground.” If these negotiations are able to corral spending and raise revenues, the CBO predicts that the deficit could fall to $551 billion by 2015, down to a sustainable 3 percent of the size of the economy. But under its rules, the CBO assumes that recently extended cuts in taxes on income, investment and people inheriting large estates will expire in two years. If those tax cuts, and numerous others, are extended, the deficit for that year would be almost three times as large. The debt held by the public could keep rising, reaching 77 percent of GDP in 2021 if current spending and tax policies are unchanged, the CBO said. Analysts say the United States should strive for a more sustainable 60 percent public debt to GDP ratio. “As disturbing as those near-term deficits are, the long-term outlook is even worse,” said Conrad. “It is the deteriorating, long-term outlook that is the biggest threat to the country’s economic security,” he added.