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Budget Deficit

Budget deficit

A budget deficit occurs when an entity (often a government) spends more money than it takes in. The opposite is a budget surplus. The size of a governmental budget deficit is often an important political issue as well as one of economic policy. Fiscal conservatives denounce deficit spending and advocate balanced budgets. Keynesians argue that under some circumstances, deficit spending is justified. "Starve-the-beast" strategies usually lead to high budget deficits. An accumulated deficit over several years (or centuries) is referred to as the government debt. Often, a certain part of spending is dedicated to paying of debt with certain maturity, which can be refinanced by issuing new government bonds. That is, a fiscal deficit leads to an increase in an entity's debt to others. Any deficit must, ultimately, be repaid, either through taxation, or seignorage. The Ricardian equivalence hypothesis states that this means a public deficit is exactly the same as a tax rise. The existence of a deficit has in some cases led to the existence of a capital market and been a great benefit to economic activity.

Early Deficits

Before the invention of bonds, the deficit could only be financed with loans from private investors. A prominent example of this was the Rothschild dynasty in the late 18th and 19th century, though there were many earlier examples. These loans became popular when private financiers had amassed enough capital to provide them, and when governments were no longer able to simply print money, with consequent inflation, to finance their spending. However, large, long-term loans had a high element of risk for the lender and consequently gave high interest rates. Governments later tried to marketize their debts by issuing bonds that were payable to the bearer, rather than the original purchaser. This meant that someone who leant the state money could sell on the debt to someone else, reducing the risks involved and reducing the overall interest rates. Examples of this are British Consols and American Treasury bill bonds.

Stuctural and Cyclical Deficits

A government deficit can be thought of as consisting of two elements, stuctural and cyclical. At the lowest point in the business cycle, there is a high level of unemployment. This means that tax revenues are low and expenditure (e.g. on social security) high. Conversely, at the peak of the cycle, unemployment is low, increasing tax revenue and decreasing social security spending. The need to borrow money at the low point of the cycle is a cyclical deficit. A cyclical deficit will be entirely repaid by a cycical surplus at the peak of the cycle. A structural deficit is the deficit that remains across the business cycle, because general tax levels are too low for the general level of government spending. The observed total budget deficit is equal to the sum of the structural deficit with the cyclical deficit or surplus. The idea of cyclical vs. stuctural deficits has come under criticism by those economists who believe that the business cycle is too difficult to measure to make cyclical analysis worthwhile.
Inflationary consequences of deficits
As a nation borrows to maintain its spending, it is in effect increasing the money supply, because the Government is promising to give money at a later date. According the the quantity theory of money, this will inevitably cause inflation down the line. Furthermore, the seignorage that the government gains from the inflation will be equal to the debt the government incurred originally. The expected inflation will increase nominal interest rates. Some governments compensate for this by requiring the central bank to increase its holdings of government debt. This neutralises the monetary effect of the deficit. However, it does raise the real interest rate, because there is now more borrowers seeking the same supply of loanable funds. At some point, however, it is necessary as resources become finite that a government cannot sustain itself on credit. Bankruptcy is the end result. This implosiion leads to social unrest and generally some form of revolution as inflation escalates consumer prices beyond norms that can be largely sustained by the masses of society.

- Fiscal Policy in the United States
- Starve-the-beast philosophy

References

- [http://news.bbc.co.uk/2/hi/business/4343814.stm "US budget deficit shrinks in 2005"]. (Oct. 14, 2005). BBC News.

External links

- [http://www.cbo.gov/ U.S. Congressional Budget Office] Category:Government finances Category:Economic policy ja:赤字

Entity

An entity is something that has a distinct, separate existence, though it need not be a material existence. In particular, abstractions and legal fictions are usually regarded as entities. In general, there is also no presumption that an entity is animate. An entity could be viewed as a set containing subsets. In philosophy, such sets are said to be abstract objects. The word 'entity' is often useful when one wants to refer to something that could be a human being, a non-human animal, a non-thinking life-form such as a plant or fungus, or a lifeless object; for instance, one could say that any entity that enters a black hole would be transported, in many pieces, to another dimension. Sometimes, the word 'entity' is used in a general sense of a being, whether or not the referent has material existence; e.g. is often referred to as an entity with no corporeal form. In law, an entity is something capable of bearing legal rights and obligations. It generally means "legal entity" or "artificial person" xor "natural person" but also includes "natural person".

Related concepts

- isness
- being
- individual
- object
- person

Specialized uses

- Entity is the root node of the SUMO ontology, and stands for the universal class of individuals.
- In VHDL, entity is the keyword for defining a new Object.
- An SGML entity is an abbreviation for some expanded piece of SGML text.
- In relational databases, an entity can refer to a table.
- In the context of the open systems architecture, an entity is an active routine within a layer.
- In Chrono Trigger (Spoiler Warning) entity is pondered upon and wondered about.

External links

- [http://www.huge-entity.com The Huge Entity] ja:物

Money

Money is any marketable good or token used by a society as a store of value, a medium of exchange, and a unit of account. Since the needs arise naturally, societies organically create a money object when none exists. In other cases, a central authority creates a money object; this is more frequently the case in modern societies with paper money. The value of money emerges in no small part from its utility as a medium of exchange, however its utility as a medium of exchange depends on it having recognised market value. Hence these two aspects of money are interdependent. Commodity money was the first form of money to emerge. Under a commodity money system, the object used as money has inherent value. It is usually adopted to simplify transactions in a barter economy; thus it functions first as a medium of exchange. It quickly begins functioning as a store of value, since holders of perishable goods can easily convert them into durable money. In modern economies, commodity money has also been used as a unit of account. Gold-backed currency notes are a common form of commodity money. Fiat money is a relatively modern invention. A central authority (government) creates a new money object that has minimal inherent value. The widespread acceptance of the fiat money is most frequently enhanced by the central authority mandating the money's acceptance under penalty of law and demands this money in payment of taxes or tribute. At various times in history government issued promisory notes have later become fiat currencies (US dollar) and fiat currencies have gone on to become a form of commodity currency (Swiss Dinar).

Essential characteristics of money

Money has all of the following three characteristics: 1. It must be a medium of exchange When an object is in demand primarily for its use in exchange -- for its ability to be used in trade to exchange for other things -- then it has this property. This characteristic allows money to be a standard of deferred payment, i.e., a tool for the payment of debt. 2. It must be a unit of account When the value of a good is frequently used to measure or compare the value of other goods or where its value is used to denominate debts then it is functioning as a unit of account. A debt or an IOU can not serve as a unit of account because its value is specified by comparison to some external reference value, some actual unit of account that may be used for settlement. For example, if in some culture people are inclined to measure the worth of things with reference to goats then we would regard goats as the dominant unit of account in that culture. For instance we may say that today a horse is worth 10 goats and a good hut is worth 45 goats. We would also say that an IOU denominated in goats would change value at much the same rate as real goats. 3. It must be a store of value When an object is purchased primarily to store value for future trade then it is being used as a store of value. For example, a sawmill might maintain an inventory of lumber that has market value. Likewise it might keep a cash box that has some currency that holds market value. Both would represent a store of value because through trade they can be reliably converted to other goods at some future date. Most non-perishable goods have this quality. Many goods or tokens have some of the characteristics outlined above. However no good or token is money unless it can satisfy all three criteria.

Credit as money

Credit is often loosely referred to as money. However credit only satisfies items one and three of the above "Essential Characteristics of Money" criteria. Credit completely fails criterion number two. Hence to be strictly accurate credit is a money substitute and not money proper. This distinction between money and credit causes much confusion in discussions of monetary theory. In lay terms, and when convenient in academic discussion, credit and money are frequently used interchangeably. For example bank deposits are generally included in summations of the national broad money supply. However any detailed study of monetary theory needs to recognize the proper distinction between money and credit. The rest of this article frequently uses the term money in the looser sense of the word.

Desirable features of money

To function as money in a modern economy, money should possess a number of features:
- It must have a stable value; a value intrinsic in itself.
- It must be difficult to counterfeit, and the genuine must be easily recognizable.
- It must be easily divisible and transportable; precious metals are divisible & a high value to weight ratio.
- It must be fungible. That is, one unit or piece must be equivalent to another.
- It must be liquid, easily tradable, with a low spread between the prices to buy and sell.

Modern forms of money

When using money anonymously, the most common methods are cash (either coin or banknotes) and stored-value cards. When using money substitutes in such a way as to leave a financial record of the transaction, the most common methods are cheques, debit cards, credit cards, and digital cash.

Money and economics

Money is one of the most central topics studied in economics and forms its most cogent link to finance. The amount of money in an economy affects inflation and interest rates and hence has profound effects. The monetary policy of government aims to manage money, inflation and interest to affect output and employment. A monetary crisis can have very significant economic effects, particularly if it leads to monetary failure and the adoption of a much less efficient barter economy. This happened in Russia (for instance) during the 1990s. Modern economics also faces a difficulty in deciding what exactly 'is' money. See money supply. There have been many historical arguments regarding the combination of money's functions, some arguing that they need more separation and that a single unit is insufficient to deal with them all. These arguments are covered in financial capital which is a more general and inclusive term for all liquid instruments, whether or not they are a uniformly recognized tender.

History of money

See main article History of money Money has developed over the years from conch shells to sophisticated international banking systems. The history of money has generally seen commodity money replaced by more formal systems, as money has been progressively brought under the control of governments.

Private currencies

In many countries, the issue of private paper currencies has been severely restricted by law. commodity money In the United States, the Free Banking Era lasted between 1837 and 1866, during which almost anyone could issue their own paper money. States, municipalities, private banks, railroad and construction companies, stores, restaurants, churches and individuals printed an estimated 8,000 different monies by 1860. If the issuer went bankrupt, closed, left town, or otherwise went out of business the note would be worthless. Such organizations earned the nickname of "wildcat banks" for a reputation of unreliability and that they were often situated in far-off, unpopulated locales that were said to be more apt to wildcats than people. On the other hand, according to Lawrence H. White's article in [http://www.fee.org/vnews.php?nid=2794 FEE] "it turns out that “wildcat” banking is largely a myth. Although stories about crooked banking practices are entertaining—and for that reason have been repeated endlessly by textbooks—modern economic historians have found that there were in fact very few banks that fit any reasonable definition of wildcat bank." The National Bank Act of 1863 ended the "wildcat bank" period. In Australia, the Bank Notes Tax Act of 1910 basically shut down the circulation of private currencies by imposing a prohibitive tax on the practice. Many other nations have similar such policies that eliminate private sector competition. In Scotland and Northern Ireland private sector banks are licensed to print their own paper money by the government. Today there are several privately issued digital currencies in circulation that function as money. Transactions in these currencies represent an annual turnover value in billions of US dollars. Many of these private currencies are backed by older forms of money such as gold (digital gold currencies). Of course, because money is the fruit of power and can be used for wielding or gaining more power, the one who accepts gold as legitimate money gives power to the people who own gold's stocks. It is possible for privately issued money to be backed by any other material, although some people argue about perishable materials. After all, gold, or platinum, or silver, have in some regards less utility than previously (their electrical properties notwithstanding), while currency backed by energy (measured in joules) or by transport (measured in kilogramme
- kilometre/hour) or by food [http://www.economist.com/markets/bigmac/displayStory.cfm?story_id=3503641] is also possible and may be accepted by the people, if legalised. It is important to understand though that, as long as money is above all an agreement to use something as a medium of exchange, its up to the community (or to the minority which holds the power) to decide whether money should be backed by whatever material or should be totally virtual. Though these private, especially digital, monies has had some modest success, governments have established a coercive monopoly on what currency may be used in lending by enacting legal tender laws. One may borrow a private currency but repay the loan with a legal tender that has subsequently devalued against the private alternative, with the lender being required by law to accept it. This large and apparently insurmountable risk to lenders severely limits the proliferation of private money, as the interest rate would have to be exhorbitant to compensate for this tremendous risk premium.

Money supply

Main article: Money supply The money supply is the amount of money available within a specific economy available for purchasing goods or services. The supply is usually considered as four escalating categories M0, M1, M2 and M3. The categories grow in size with M3 representing all forms of money (including credit) and M0 being just base money (coins, bills, and central bank deposits). M0 is also money that can satisfy private banks' reserve requirements. In the United States, the Federal Reserve is responsible for controlling the money supply (monetary policy).

Growing the money supply

Historically money was a metal (gold, silver, etc,) or other object that was difficult to duplicate, but easy to transport and divide. Later it consisted of paper notes, now issued by all modern governments. With the rise of modern industrial capitalism it has gone through several phases including but not limited to: #Bank notes - paper issued by banks as an interest-bearing loan. (These were common in the 19th century but not seen anymore.) #Paper notes, coins with varying amounts of precious metal (usually called legal tender) issued by various governments. There is also a near-money in the form of interest bearing bonds issued by governments with solid credit ratings. #Bank credit through the creation of chequable deposits in the granting of various loans to business, government and individuals. (It is critical that we understand that when a bank makes a loan, that is new money and when a loan is paid off that money is destroyed. Only the interest paid on it remains.) Thus, all debt denominated in dollars -- mortgages, money markets, credit card debt, travelers cheques -- is money. However, the creation of dollar-denominated debt (or any generic obligation) only creates money when a bank (as opposed to a credit card company) is granting the debt. "High powered" money (M0) is created when the elected government spends money into the economy. The money created in the bank loan process is bank money and these two forms of money trade at par one with the other. Banks are limited in the amount of loans they can grant and thus in the amount of bank money (credit) they can create by both the net assets of the bank and by reserve requirements (M0). For most intents and purposes the aggregate of M0 multiplied by the reserve requirement will be an indicator of (but this is somewhat greater than) the aggregate of loans. If additional money is needed in the banking system to allow more loans the Federal Reserve will create money by purchasing Bonds or T-bills with money created from the ether. No matter who sells the bonds the money will end up in the banking system as M0. The Fed could purchase lolly pops if that would accomplish the purpose of expansion better than a purchase of Bonds.

Shrinking the money supply (M3)

Perhaps the most obvious way money can be destroyed is if paper bills are burned or taken out of circulation by the central bank. But, it should be remembered that legal tender usually constitutes less than 4% of the broad money supply. Another way money can be destroyed is when any bank loan is paid off or any government bond or T-Bill is purchased by the private sector. The money value of the contract or bond is destroyed — taken out of circulation. If a bank loan is defaulted upon then the "interest" paid by other borrowers will be employed to cover the default. A very large part of the "interest" paid on bank loans is actually a finance charge employed to cover bad loans. The group of good borrowers pay the loan instead of the original borrower. In cases where the default is huge such as loans to foreign governments Fed intervention has, in the past, rescued the banks. In this instance it would seem that the taxpayers and/or money holders (savers) will pay the debt. The effects on the money supply will be controlled, again, by the level of bond purchase or redemption or the level of T-Bill sales or purchases by the Treasury. Money can be destroyed if savers withdraw funds from a bank, in which case that money can no longer be used for lending. Bank savings are actually a kind of loans — savers loan their money to a bank at a low interest rate or merely in exchange for the benefit of convenience or its security (accepting that they lose a small amount of value to inflation). The bank may use this loan to manage its liabilities (its deposit liabilities created by loans). It must be recalled that the federal reserve banking system is mostly a closed system. A check written on bank A gets deposited in Bank B and a check written on bank B gets deposited in Bank C and a check on bank C gets deposited in bank A. At the end of the day the bankers go have a beer and see who needs to borrow from whom:) On a good day very little borrowing needs to be done because a bank gets as much in new deposits as it does in paid out funds. Even if a bank is short of reserves it can borrow the reserves from another bank at the discount rate. In extreme forms, a bank run or panic may drive a bank into insolvency and, if uninsured, the savings of all its depositors are lost. Such bank failures were a major cause of the tremendous contraction in the money supply that occurred during the Great Depression, particularly in the United States. In that country many banking reforms were subsequently enacted during the New Deal, including the creation of the Federal Deposit Insurance Corporation to guarantee private bank deposits.

External links

- [http://www.bu.edu/wcp/Papers/Econ/EconShep.htm Philosophy of Money] by Alla Sheptun
- [http://www.eh.net/ehresources/howmuch/poundq.php How much is that worth today?] - Comparing the purchasing power of money in Britain from 1600 to any other year up to 2002.
- [http://www.metrum.org/measures/heraion.htm The Heraion Standard. The first attempt to create money.]
- [http://www.nsf.gov/news/news_summ.jsp?cntn_id=100362&org=NSF Shell Beads from South African Cave Show Modern Human Behavior 75,000 Years Ago]
- [http://www.chabad.org/article.asp?AID=69943 Jewish view of money] ko:돈 ja:貨幣 simple:Money

Economic policy

Economic Policy refers to the actions that governments take in the economic field. It covers the systems for setting interest rates and government deficit as well as the labour market, national ownership, and many other areas of government. Such policies are often influenced by international institutions like the IMF or World Bank as well as political beliefs and the consequent policies of parties.

Types of Economic Policy

Economic policy is a complicated area and can be broken down into three principal areas:
- Fiscal policy is the size of the government deficit and the methods it uses to finance it.
- Fiscal stance: The size of the deficit
- Tax policy: The taxes used to collect government income.
- Government spending on just about any area of government
- Monetary policy is concerned with the amount of money in circulation and, consequently, interest rates and inflation.
- Interest rates, if set by the Government
- Incomes policies which aim at imposing non-monetary controls on inflation
- Bank regulations which affect the money multiplier
- Trade policy refers to tariffs, trade agreements and the international institutions that govern them. Almost any aspect of government has an economic aspect and so many terms are used. However, they can usually be seen to apply to one of these areas. For instance, agricultural policy is generally a matter of the burden of taxation and of trade in agricultural goods.

Tools and Goals

Policy is generally directed to achieve particular objectives, like targets for inflation, unemployment, or economic growth. Sometimes other objectives, like military spending or nationalization are important. These are referred to as the policy goals: the outcomes which the economic policy aims to achieve. To achieve these goals, governments use policy tools which are under the control of the government. These generally include the interest rate and money supply, tax and government spending, tariffs, exchange rates, labour market regulations, and many other aspects of government. The government's economic policy determines the tools and hopes that they will achieve its goals.

Selecting tools and goals

Governments and central banks are limited in the number of goals they can achieve in the short term. For instance, there may be pressure on the government to reduce inflation, reduce unemployment, and reduce interest rates while maintaining currency stability. If all of these are selected as goals for the short term, then policy is likely to be incoherent, because a normal consequence of reducing inflation and maintaining currency stability is increasing unemployment and increasing interest rates.

Demand-side vs. supply-side tools

This dilemma can in part be resolved by using microeconomic, supply-side policy to help adjust markets. For instance, unemployment could potentially be reduced by altering laws relating to trade unions or unemployment insurance, as well as by macroeconomic (demand-side) factors like interest rates.

Discretionary Policy vs Policy Rules

For much of the 20th century, governments adopted discretionary policys like demand management designed to correct the business cycle. These typically used fiscal and monetary policy to adjust inflation, output and unemployment. However, following the stagflation of the 1970s, policymakers began to be attracted to policy rules. A discretionary policy is supported because it allows policymakers to respond quickly to events. However, discretionary policy can be subject to dynamic inconsistency: a government may say it intends to raise interest rates indefinitely to bring inflation under control, but then relax its stance later. This makes policy non-credible and ultimately ineffective. A rule-based policy can be more credible, because it is more transparent and easier to anticipate. Examples of rule-based policies are fixed exchange rates, interest rate rules, the stability and growth pact and the Golden Rule. Some policy rules can be imposed by external bodies, for instance the Exchange Rate Mechanism for currency. A compromise between strict discretionary and strict rule-based policy is to grant discretionary power to an independent body. For instance, the Federal Reserve Bank, European Central Bank and Bank of England all set interest rates without government interference, but do not adopt rules. Another type of non-discretionary policy is a set of policies which are imposed by an international body. This can occur (for example) as a result of intervention by the International Monetary Fund.

Economic Policy through History

Main article: Economic History The first economic problem was how to gain the resources it needed to be able to perform the functions of an early government: the military, roads and other projects like building the Pyramids. Early governments generally relied on tax in kind and forced labour for their economic resources. However, with the development of money came the first policy choice. A government could raise money through taxing its citizens. However, it could now also debase the coinage and so increase the money supply. Early civlizations also made decisions about whether to permit and how to tax trade. Some early civilizations, such as Ptolemaic Egypt adopted a closed currency policy whereby foreign merchants had to exchange their coin for local money. This effectively levied a very high tariff on foreign trade. By the early modern age, more policy choices had been developed. There was considerable debate about mercantilism and other restrictive trade practices like the Navigation Acts, as trade policy became associated with both national wealth and with foreign and colonial policy. Throughout the 19th Century, monetary standards became an important issue. Gold and silver were in supply in different proportions which metal was adopted influenced the wealth of diferent groups in society.

The first fiscal policy

With the accumulation of private capital in the Renaissance, states developed methods of financing deficits without debasing their coin. The development of capital markets meant that a government could borrow money to finance war or expansion while causing less economic hardship. This was the beginning of modern fiscal policy. The same markets made it easy for private entities to raise bonds or sell shares to fund private initiatives.

Business cycles

The business cycle became a predominant issue in the 19th century, as it became clear that industrial output, employment, and profit behaved in a cyclical manner. The first real policy solution to the problem came with the work of Keynes, who proposed that fiscal policy could be used actively to ward off depressions, recessions and slumps.

Deficit spending

Deficit spending is the amount by which a government, private company, or individual's spending exceeds income over a particular period of time, also called simply "deficit," or "budget deficit," the opposite of budget surplus.

Government Deficits

Even though households and companies often engage in deficit spending, it is typically only when the government does so that it sparks a controversy. Like other institutions, governments operate on a budget -- or try to do so. When the expenditures of a government (its purchases of goods and services, plus its transfers (grants) to individuals and corporations) are greater than its tax revenues, it creates a deficit in the government budget. When tax revenues exceed government purchases and transfer payments, the government has a budget surplus (as in the late 1990s in the United States).

Keynesian Effect

Following John Maynard Keynes, many economists recommend deficit spending in order to moderate or end a recession, especially a severe one. When the economy has high unemployment, an increase in government purchases create a market for business output, creating income and encouraging increases in consumer spending, which creates further increases in the demand for business output. (This is the multiplier effect). This raises the real gross domestic product (GDP) and the employment of labor, all else constant lowering the unemployment rate. (The connection between demand for GDP and unemployment is called Okun's Law.) Cutting personal taxes and/or raising transfer payments can have similar expansionary effects, though most economists would say that such policies have weaker effects on aggregate demand. On the other hand, if supply-side (non-Keynesian) effects are brought into consideration, which method has a better stimulative economic effect is a matter of debate. The increased size of the market, due to government deficits, can further stimulate the economy by raising business profitability and spurring optimism, which encourages private fixed investment in factories, machines, and the like to rise. This accelerator effect stimulates demand further and encourages rising employment. Similarly, running a government surplus or reducing its deficit reduces consumer and business spending and raises unemployment. This can lower the inflation rate. Any use of the government deficit to steer the macro-economy is called fiscal policy. A deficit does not simply stimulate demand. If private investment is stimulated, that increases the ability of the economy to supply output in the long run. Also, if the government's deficit is spent on such things as infrastructure, basic research, public health, and education, that can also increase potential output in the long run. (These are public goods which are very unlikely to be provided by private initiatives.) Finally, the high demand that a government deficit provides may actually allow greater growth of potential supply, following Verdoorn's Law. There is, however, a danger that deficit spending may create inflation -- or encourage existing inflation to persist. (In the United States, this is seen most clearly when Vietnam-war era deficits encouraged inflation.) This is especially true at low unemployment rates (say, below 4% unemployment in the U.S.). But government deficits are not the only cause of inflation: it can arise due to such supply-side shocks as the "oil crises" of the 1970s and inflation left over from the past (inflationary expectations and the price/wage spiral). There must also be enough money circulating in the system to allow inflation to persist -- so that inflation depends on monetary policy.

Loanable Funds

A government deficit also impacts the economy through the loanable funds market. When there isn't enough tax money to cover outlays, the government must borrow. This increases the demand for loanable funds and thus (ignoring other changes) pushes up interest rates. Rising interest rates can "crowd out" (discourage) fixed private investment spending, cancelling out some or even all of the demand stimulus arising from the deficit -- and perhaps hurting long-term supply-side growth. But increased deficits also raise the amount of total income received, which raises the amount of saving done by individuals and corporations and thus the supply of loanable funds, lowering interest rates. Thus, crowding out is a problem only when the economy is already close to full employment (say, at about 4% unemployment) and the scope for increasing income and saving is blocked by resource constraints (potential output). It should be noted that despite a government debt that exceeded GDP in 1945, the U.S. saw the long prosperity of the 1950s and 1960s. The growth of the "supply side", it seems, was not hurt by the large deficits and debts. A government deficit leads to increased government debt (often confusingly called the "national debt" or the "public debt"). In the U.S., the government borrows by selling bonds (T-bills, etc.) rather than getting loans from banks. The most important burden of this debt is the interest that must be paid to bond-holders, which restricts a government's ability to raise its outlays or cut taxes to attain other goals. Further, most of the government debt is owned by rich people, so that a rising debt can raise the demand for the funds supplied by the rich, encouraging income inequality.

Government Deficits Good or Bad?

Whether government deficits are good or bad cannot be decided without examining the specifics. Just as with borrowing by individuals or businesses, it can be good or bad. If the government borrows (runs a deficit) to deal with a severe recession (or depression), to help self-defense, or is spent on public investment (in infrastructure, education, basic research, or public health), the vast majority of economists would agree that the deficit is bearable, beneficial, and even necessary. If, on the other hand, the deficit finances wasteful expenditure or current consumption, most would recommend tax hikes, transfer cuts, and/or cuts in government purchases to balance the budget.

Unintentional deficits

Not all government deficits are intentional, a result of policy decisions. When an economy goes into a recession (say, due to monetary policy), deficits usually rise, at least in the U.S. and other large, rich, countries: with less economic activity, a relatively progressive tax system implies that tax revenues automatically fall. Similarly, transfer payments such as unemployment insurance benefits and food stamp grants rise. Most economists agree that raising taxes or cutting government spending (or both) is a big mistake in this situation: U.S. President Herbert Hoover made the Great Depression greater by raising taxes (and cutting demand further) in the early 1930s. Instead, he should have relied on the increased deficit to moderate the recession. This is called automatic (or built-in) stabilization. (Similarly, a rise in GDP and employment automatically causes the government deficit to shrink in size, discouraging over-heating and inflation.)

Automatic vs. Active deficit policies

Most economists favor the use of automatic stabilization over active or discretionary use of deficits to fight mild recessions (or surpluses to fight inflation). Active policy-making takes too long for politicians to institute and too long to affect the economy. Often, the medicine ends up affecting the economy only after its disease has been cured, leaving the economy with side-effects such as inflation. For example, President John F. Kennedy proposed tax cuts in response to the high unemployment of 1960, but these were instituted only in 1964 and impacted the economy only in 1965 or 1966 and encouraged inflation then, reinforcing the effect of Vietnam war spending. The vast majority of economists are now in favor of monetary policy to replace active use of deficits or surpluses.

Keynesianism

Keynesian economics (pronounced KAYNzian), is an economic theory based on the ideas of John Maynard Keynes, as put forward in his book The General Theory of Employment, Interest and Money, published in 1936 in response to the Great Depression of the 1930s. In Keynes's theory, general (macro-level) trends can overwhelm the micro-level behavior of individuals. Instead of the economic process being based on continuous improvements in potential output, as most classical economics had focused on from the late 1700s, Keynes asserted the importance of the aggregate demand for goods as the driving factor, especially in downturns. From this he argued that government policies could be used to promote demand at a "macro" level, to fight high unemployment and deflation of the sort seen during the 1930s. A central conclusion of Keynesian economics is that there is no strong automatic tendency for output and employment to move toward full employment levels. This, Keynes thought, conflicts with the tenets of classical economics, and those schools, such as supply side economics, the Austrian School of economics which assume a general tendency towards equilibrium in a restrained money creation economy. In neoclassical economics, which combines Keynesian macro concepts with a micro foundation, the conditions of General equilibrium allow that price adjustment will achieve this goal. More broadly, Keynes saw this as a general theory, in which resource utilization could be high or low, whereas previous economics focused on the particular case of full utilization.

Historical background

John Maynard Keynes was one of a wave of thinkers who perceived increasing cracks in the assumptions and theories which held sway at that time. As physics questioned the necessity of absolute time, writers the structured narrative, and composers the need for tonal harmony—Keynes questioned two of the dominant pillars of economic theory: the need for a solid basis for money, generally a gold standard, and the theory, expressed as Say's Law which stated that decreases in demand would only cause price declines, rather than affecting real output and employment. In his political views, Keynes was no revolutionary. He was pro-business and pro-entrepreneur, but was very critical of rentiers and speculators, from a somewhat Fabian perspective. He was a "new" or modern liberal. It was his experience with the Treaty of Versailles which pushed him to make a break with previous theory. His The Economic Consequences of the Peace (1920) not only recounted the general economics, as he saw them, of the Treaty, but the individuals involved in making it. The book established him as an economist who had the practical political skills to influence policy. In the 1920s, Keynes published a series of books and articles which focused on the effects of state power and large economic trends, developing the idea of monetary policy as something separate from merely maintaining currency against a fixed peg. He increasingly believed that economic systems would not automatically right themselves to attain "the optimal level of production." This is expressed in his famous quote, "In the long run, we are all dead", implying that it doesn't matter that optimal production levels are attained in the long run, because it'd be a very long run indeed. However, he neither had proof, nor a formalism to express these ideas. In the late 1920s, the world economic system began to break down, after the shaky recovery that followed World War I. With the global drop in production, critics of the gold standard, market self-correction, and production-driven paradigms of economics moved to the fore. Dozens of different schools contended for influence. Further, some pointed to the Soviet Union as a successful planned economy which had avoided the disasters of the capitalist world and argued for a move toward socialism. Others pointed to the alleged success of fascism in Mussolini's Italy. Into this tumult stepped Keynes, promising not to institute revolution but to save capitalism. He circulated a simple thesis: there were more factories and transportation networks than could be used at the current ability of individuals to pay and that the problem was on the demand side. But many economists still insisted that business confidence, not lack of demand, was the root of the problem, and that the correct course was to slash government expenditures and to cut wages to raise business confidence and willingness to hire unemployed workers. Yet others simply argued that "nature would make its course," solving the Depression automatically by "shaking out" unneeded productive capacity.

Keynes and the Classics

Keynes explained the level of output and employment in the economy as being determined by aggregate demand or effective demand. In a reversal of Say's Law, Keynes in essence argued that "man creates his own supply," up to the limit set by full employment. In "classical" economic theory—Keynes's term for the economics prior to General Theory (and specifically that of Arthur Pigou)—adjustments in prices would automatically make demand tend to the full employment level. Keynes, pointing to the sharp fall in employment and output in the early 1930s, argued that whatever the theory, this self-correcting process had not happened. In the neo-classical theory, the two main costs are those of labor and money. If there was more labor than demand for it, wages would fall until hiring began again. If there was too much saving, and not enough consumption, then interest rates would fall until either people cut saving or started borrowing. These two price adjustments would always enforce Say's Law, and therefore the economy would be at the optimal level of output.

Wages and spending

Even in the worst years of the Depression, the classical theory defined economic collapse as simply a lost incentive to produce. Mass unemployment was caused only by high and rigid real wages. The proper solution was to cut wages. To Keynes, the determination of wages is more complicated. First, he argued that it is not real but nominal wages that are set in negotiations between employers and workers. It's not a barter relationship. First, nominal wage cuts would be difficult to put into effect because of laws and wage contracts. Even classical economists admitted that these exist; unlike Keynes, they advocated abolishing minimum wages, unions, and long-term contracts, increasing labor-market flexibility. However, to Keynes, people will resist nominal wage reductions, even without unions, until they see other wages falling and a general fall of prices. (His prediction that mass unemployment would be necessary to deflate sterling wages back to pre-war gold values had been proven right in the 1920s). He also argued that to boost employment, real wages had to go down: nominal wages would have to fall more than prices. However, doing so would reduce consumer demand, so that the aggregate demand for goods would drop. This would in turn reduce business sales revenues and expected profits. Investment in new plant and equipment—perhaps already discouraged by previous excesses—would then become more risky, less likely. Instead of raising business expectations, wages cuts could make matters much worse. Further, if wages and prices were falling, people would start to expect them to fall. This could make the economy spiral downward as those who had money would simply wait as falling prices made it more valuable—rather than spending. As Irving Fisher argued in 1933, in his Debt-Deflation Theory of Great Depressions, deflation (falling prices) can make a depression deeper as falling prices and wages made pre-existing nominal debts more valuable in real terms.

Excessive saving

deflation

To Keynes, excessive saving, i.e. saving beyond planned investment, was a serious problem encouraging recession or even depression. Excessive saving results if investment falls, perhaps due to falling consumer demand, over-investment in earlier years, or pessimistic business expectations, and if saving does not immediately fall in step. The classical economists argued that interest rates would fall due to the excess supply of "loanable funds." The first diagram, adapted from the only graph in The General Theory, shows this process. (For simplicity, other sources of the demand for or supply of funds are ignored here.) Assume that fixed investment in plant and equipment falls from "old I" to "new I" (step a). Second (step b), the resulting excess of saving causes interest-rate cuts, abolishing the excess supply: so again we have saving (S) equal to investment. The interest-rate fall prevents that of production and employment. Keynes had a complex argument against this laissez-faire response. The graph below summarizes his argument, assuming again that fixed investment falls (step A). First, saving does not fall much as interest rates fall, since the income and substitution effects of falling rates go in conflicting directions. Second, since planned fixed investment in plant and equipment is mostly based on long-term expectations of future profitability, that spending does not rise much as interest rates fall. So S and I are drawn as steep (inelastic) in the graph. Given the inelasticity of both demand and supply, a large interest-rate fall is needed to close the saving/investment gap. As drawn, this requires a negative interest rate at equilibrium (where the new I line would intersect the old S line). However, this negative interest rate is not necessary to Keynes's argument.

Keynes on Saving and Investment.

Third, Keynes argued that saving and investment are not the main determinants of interest rates, especially in the short run. Instead, the supply of and the demand for the stock of money determine interest rates in the short run. (This is not drawn in the graph.) Neither change quickly in response to excessive saving to allow fast interest-rate adjustment. Finally, because of fear of capital losses on assets besides money, Keynes suggested that there may be a "liquidity trap" setting a floor under which interest rates cannot fall. (In this trap, bond-holders, fearing rises in interest rates (because rates are so low), fear capital losses on their bonds and thus try to sell them to attain money (liquidity).) Even economists who reject this liquidity trap now realize that nominal interest rates cannot fall below zero (or slightly higher). In the diagram, the equilibrium suggested by the new I line and the old S line cannot be reached, so that excess saving persists. Some (such as Paul Krugman) see this latter kind of liquidity trap as prevailing in Japan in the 1990s. Even if this "trap" does not exist, there is a fourth element to Keynes's critique (perhaps the most important part). Saving involves not spending all of one's income. It thus means insufficient demand for business output, unless it is balanced by other sources of demand, such as fixed investment. Thus, excessive saving corresponds to an unwanted accumulation of inventories, or what classical economists called a "[http://cepa.newschool.edu/het/essays/classic/glut.htm general glut]". This pile-up of unsold goods and materials encourages businesses to decrease both production and employment. This in turn lowers people's incomes—and saving, causing a leftward shift in the S line in the diagram (step B). For Keynes, the fall in income did most of the job ending excessive saving and allowing the loanable funds market to attain equilibrium. Instead of interest-rate adjustment solving the problem, a recession does so. Thus in the diagram, the interest-rate change is small. Whereas the classical economists assumed that the level of output and income was constant and given at any one time (except for short-lived deviations), Keynes saw this as the key variable that adjusted to equate saving and investment. Finally, a recession undermines the business incentive to engage in fixed investment. With falling incomes and demand for products, the desired demand for factories and equipment (not to mention housing) will fall. This accelerator effect would shift the I line to the left again, a change not shown in the diagram above.. This recreates the problem of excessive saving and encourages the recession to continue. In sum, to Keynes there is interaction between excess supplies in different markets, as unemployment in labor markets encourages excessive saving—and vice-versa. Rather than prices adjusting to attain equilibrium, the main story is one of quantity adjustment allowing recessions and possible attainment of underemployment equilibrium.

Active fiscal policy

As noted, the classicals wanted to balance the government budget, through slashing expenditures or (more rarely) raising taxes. To Keynes, this would exacerbate the underlying problem: following either policy would raise saving (broadly defined) and thus lower the demand for both products and labor. For example, Keynesians see Herbert Hoover's June 1932 tax hike as making the Depression worse. Keynes's ideas influenced Franklin D. Roosevelt's view that insufficient buying-power caused the Depression. During his presidency, he adopted some aspects of Keynesian economics, especially after 1937, when, in the depths of the Depression, the United States suffered from recession yet again. Something similar to Keynesian expansionary policies had been applied earlier by both social-democratic Sweden and Nazi Germany. But to many the true success of Keynesian policy can be seen at the onset of World War II, which provided a kick to the world economy, removed uncertainty, and forced the rebuilding of destroyed capital. Keynesian ideas became almost official in social-democratic Europe after the war and in the U.S. in the 1960s. Keynes's theory suggested that active government policy could be effective in managing the economy. Rather than seeing unbalanced government budgets as wrong, Keynes advocated what has been called counter-cyclical fiscal policies, that is policies which acted against the tide of the business cycle: deficit spending when a nation's economy suffers from recession or when recovery is long-delayed and unemployment is persistently high—and the suppression of inflation in boom times by either increasing taxes or cutting back on government outlays. He argued that governments should solve short-term problems rather than waiting for market forces to do it, because "in the long run, we are all dead." This contrasted with the classical and neoclassical economic analysis of fiscal policy. Fiscal stimulus (deficit spending) could stimulate production. But to these schools, there was no reason to believe that this stimulation would outrun the side-effects that "crowd out" private investment: first, it would increase the demand for labor and raise wages, hurting profitability. Second, a government deficit increases the stock of government bonds, reducing their market price and encouraging high interest rates, making it more expensive for business to finance fixed investment. Thus, efforts to stimulate the economy would be self-defeating. Worse, it would be shifting resources away from productive use by the private sector to wasteful use by the government. The Keynesian response is that such fiscal policy is only appropriate when unemployment is persistently high, above what is now termed the "NAIRU". In that case, crowding out is minimal. Further, private investment can be "crowded in": fiscal stimulus raises the market for business output, raising cash flow and profitability, spurring business optimism. To Keynes, this accelerator effect meant that government and business could be complements rather than substitutes in this situation. Second, as the stimulus occurs, gross domestic product rises, raising the amount of saving, helping to finance the increase in fixed investment. Finally, government outlays need not always be wasteful: government investment in public goods that will not be provided by profit-seekers will encourage the private sector's growth. That is, government spending on such things as basic research, public health, education, and infrastructure could help the long-term growth of potential output. Invoking public choice theory, classical and neoclassical economists doubt that the government will ever be this beneficial and suggest that its policies will typically be dominated by special interest groups, including the government bureaucracy. Thus, they use their political theory to reject Keynes' economic theory. In Keynes' theory, there must be significant slack in the labor market before fiscal expansion is justified. Both conservative and some neoliberal economists question this assumption, unless labor unions or the government "meddle" in the free market, creating persistent supply-side or classical unemployment. Their solution is to increase labor-market flexibility, i.e., by cutting wages, busting unions, and deregulating business. It is important to distinguish between mere deficit spending and Keynesianism. Governments had long used deficits to finance wars. But Keynesian policy is not merely spending. Rather, it is the proposition that sometimes the economy needs active fiscal policy. Further, Keynesianism recommends counter-cyclical policies, for example raising taxes when there is abundant demand-side growth to cool the economy and to prevent inflation, even if there is a budget surplus. Classical economics, on the other hand, argues that one should cut taxes when there are budget surpluses, to return money to private hands. Because deficits grow during recessions, classicals call for cuts in outlays—or, less likely, tax hikes. On the other hand, Keynesianism encourages increased deficits during downturns. In the Keynesian view, the classical policy exacerbates the business cycle. In the classical view, of course, Keynesianism is topsy-turvy policy, almost literally fiscal madness.

The "Multiplier effect" and interest rates

Two aspects of Keynes's model had implications for policy: First, there is the "Keynesian multiplier", first developed by Richard F. Kahn in 1931. The effect on demand of any exogenous increase in spending, such as an increase in government outlays is a multiple of that increase—until potential is reached. Thus, a government could stimulate a great deal of new production with a modest outlay: if the government spends, the people who receive this money then spend most on consumption goods and save the rest. This extra spending allows businesses to hire more people and pay them, which in turn allows a further increase consumer spending. This process continues. At each step, the increase in spending is smaller than in the previous step, so that the multiplier process tapers off and allows the attainment of an equilibrium. This story is modified and moderated if we move beyond a "closed economy" and bring in the role of taxation: the rise in imports and tax payments at each step reduces the amount of induced consumer spending and the size of the multiplier effect. Second, Keynes re-analyzed the effect of the interest rate on investment. In the classical model, the supply of funds (saving) determined the amount of fixed business investment. To Keynes, the amount of investment was determined independently by long-term profit expectations and, to a lesser extent, the interest rate. The latter opens the possibility of regulating the economy through money supply changes, via monetary policy. Under conditions such as the Great Depression, Keynes argued that this approach would be relatively ineffective compared to fiscal policy. But during more "normal" times, monetary expansion can stimulate the economy, mostly by encouraging construction of new housing.

Subsequent developments in Keynesian thought

After Keynes, Keynesian analysis was combined with classical economics to produce what is generally termed "the neoclassical synthesis" which dominates mainstream macroeconomic thought. Though it was widely held that there was no strong automatic tendency to full employment, many believed that if government policy were used to ensure it, the economy would behave as classical or neoclassical theory predicted. In the post-WWII years, Keynes's policy ideas were widely accepted. For the first time, governments prepared good quality economic statistics on an ongoing basis and a theory that told them what to do. In this era of new liberalism and social democracy, most western capitalist countries enjoyed low, stable unemployment and modest inflation. It was with John Hicks that Keynesian economics produced a clear model which policy-makers could use to attempt to understand and control economic activity. This model, the IS-LM model is nearly as influential as Keynes' original analysis in determining actual policy and economics education. It relates aggregate demand and employment to three exogenous quantities, i.e., the amount of money in circulation, the government budget, and the state of business expectations. This model was very popular with economists after World War II because it could be understood in terms of general equilibrium theory. This encouraged a much more static vision of macroeconomics than that described above. The second main part of a Keynesian policy-maker's theoretical apparatus was the Phillips curve. This curve, which was more of an empirical observation than a theory, indicated that increased employment, and decreased unemployment, implied increased inflation. Keynes had only predicted that falling unemployment would cause a higher price, not a higher inflation rate. Thus, the economist could use the IS-LM model to predict, for example, that an increase in the money supply would raise output and employment—and then use the Phillips curve to predict an increase in inflation. The strength of Keynesianism's influence can be seen by the wave of conservative economists which began in the late 1940s with Milton Friedman. Instead of rejecting macro-measurements and macro-models of the economy, they embraced the techniques of treating the entire economy as having a supply and demand equilibrium. But unlike the Keynesians, they argued that the "crowding out" effects discussed above would hobble or deprive fiscal policy of its positive effect. Instead, the focus should be on monetary policy, which was largely ignored by early Keynesians. This monetarism had an ideological as well as a practical appeal: monetary policy does not, at least on the surface, imply as much government intervention in the economy as other measures. The monetarist critique pushed Keynesians toward a more balanced view of monetary policy, and inspired a wave of revisions to Keynesian theory. Through the 1950s, moderate degrees of government demand leading industrial development, and use of fiscal and monetary counter-cyclical policies continued, and reached a peak in the "go go" 1960s, where it seemed to many Keynesians that prosperity was now permanent. However, with the oil shock of 1973, and the economic problems of the 1970s, modern liberal economics began to fall out of favor. During this time, many economies experienced high and rising unemployment, coupled with high and rising inflation, contradicting the Phillips curve's prediction. This stagflation meant that both expansionary (anti-recession) and contractionary (anti-inflation) policies had to be applied simultaneously, a clear impossibility. This dilemma led to the rise of ideas based upon more classical analysis, including monetarism, supply-side economics and new classical economics. This produced a "policy bind" and the collapse of the Keynesian consensus on the economy. In the 1990s the "uncoupling" of money supply and inflation caused an increasing questioning of the original form of monetarism. The repeated failures of projections for economic recovery in Japan and the United States based on neo-classical synthesis models, as well as the failure of "big bang" marketization in the former Soviet Bloc, have encouraged the recent revival in Keynesian ideas, with particular emphasis on giving the Keynesian macroeconomic analysis theoretically sound foundations in microeconomics. These theories have been called new Keynesian economics. The heart of the new Keynesian view rests on microeconomic models that indicate that nominal wages and prices are "sticky," i.e., do not change easily or quickly with changes in supply and demand, so that quantity adjustment prevails. This is a practice which, according to economist Paul Krugman "never works in theory, but works beautifully in practice." This integration is further spurred by work of other economists which questions rational decision-making in a perfect information environment as a necessity for micro-economic theory. Imperfect decision making such as that investigated by Joseph Stiglitz underlines the importance of management of risk in the economy. New classical economics relied on the theory of rational expectations to reject Keynesian economics. Most well-known is the critique by Robert Lucas, who argues that rational expectations will defeat any monetary or fiscal policy. But new Keynesians argue that this critique only works if the economy has a unique equilibrium at full employment. Price stickiness means that there are a variety of possible equilibria in the short run, so that rational expectations models do not produce any simple result. In the end, many macroeconomists have returned to the IS-LM model and the Phillips Curve as a first approximation of how an economy works. New versions of the Phillips Curve, such as the "Triangle Model", allow for stagflation, since the curve can shift due to supply shocks or changes in built-in inflation. In the 1990s, the original ideas of "full employment" had been replaced by the NAIRU theory, sometimes called the "natural rate of unemployment." This theory pointed to the dangers of getting unemployment too low, because accelerating inflation can result. However, it is unclear exactly what the value of the NAIRU is—or whether it really exists or not. While the Keynesian triumphalism of the 1960s is certainly not due for a revival, Keynesian ideas persist, often used to attain very conservative goals. Many observers find it hard to distinguish the new Keynesianism from old monetarism, except that the latter's emphasis on the money supply has been dropped or downgraded. Of course, for a relatively open economy such as that of the United Kingdom and almost all other countries, this simple Keynesianism must be complemented by considerations of foreign exchange markets, foreign exchange rates, and the balance of payments. Also needed is an understanding of issues of long-term growth of potential. The open economy considerations which were the basis of the conservative or neo-liberal revival of policy, were then codified by Keynesian economists. According to the Stability and Growth Pact, the countries of the Eurozone in theory have limited possibilities to follow Keynesian fiscal policy since they are required to have an annual budget deficit lower than 3% of GDP. Monetary policy is also constrained, since it is done only by the European Central Bank. The journalist and economist Will Hutton regards Gordon Brown as being the first "real" Keynesian Chancellor of the Exchequer, although an argument could be made for Stafford Cripps and Roy Jenkins. U.S. President Nixon once said, "we are all Keynesians now."

External link

- See Friedrich A. von Hayek's [http://www.iea.org.uk/files/upld-publication43pdf?.pdf Road to Serfdom] for a critique of Keynesian economics from the perspective of one of the leaders of the Austrian school of economics. Herman Feiners' book "The Road to Reaction" provides a criticism of Hayek. ja:ケインズ経済学

Starve-the-beast

Starve-the-beast is a strategy of using budget deficits in order to force the government to reduce its social spending; a timely example is the tax cutting and war starting policy under U.S. President George W. Bush. The word beast in the expression refers to the government and the social programs it funds, such as Social Security, Medicare, Medicaid, and TANF (Temporary Assistance for Needy Families), and implies that these social programs are destructive. A current well-known proponent of starve-the-beast in the U.S. is Grover Norquist. It appears the earliest reference to "starving the beast" as a doctrine was made during the Reagan administration by White House budget director David Stockman, to describe its fiscal philosophy. Some empirical evidence shows that the strategy may actually be counterproductive, with higher taxes actually corresponding to lower spending: "Controlling for the unemployment rate, federal spending [from 1981 to 2000] increased by about one-half percent of GDP for each one percentage point decline in the relative level of federal tax revenues." The article (written by William Niskanen and Peter Van Doren of the Cato Institute) shows that "a tax increase may be the most effective policy to reduce the relative level of federal spending," though the authors oppose tax increases for other reasons.[http://volokh.com/archives/archive_2004_05_14.shtml#1085086959] Additionally, some economists and politicians see the budget deficits created by this strategy as harmful to the economy.

External link

- [http://www.wordspy.com/words/starvethebeast.asp The Word Spy - starve the beast]

Government bond

A government bond is a bond issued by a national government denominated in the country's own currency. Bonds issued by national governments in foreign currencies are normally referred to as sovereign bonds.

Risk

Government bonds are usually referred to as risk-free bonds, because the government can raise taxes or simply print more money to redeem the bond at maturity. Some counterexamples do exist where a government has defaulted on its domestic currency debt, such as Russia in 1998, though this is very rare. As an example, in the US, Treasury securities are denominated in US dollars and are the safest US dollar investments. In this instance, the term risk-free means free of credit risk. However, other risks still exist: such as currency risk for foreign investors (for example non-US investors of US Treasuries would have received lower returns in 2004 because the value of the US dollar declined against most other currencies). Secondly, there is inflation risk - in that the principal repaid at maturity will have less purchasing power than anticipated if the inflation outturn is higher than expected. Many governemnts issue inflation-indexed bonds, which protect investors against inflation risk.

Issuance

Government bonds are issued through agencies that are part of the government's treasury department, for example
- Bunds are bonds issued by the German Finance Agency, denominated in euros
- Gilts are bonds issued by the UK Debt Management Office and are denominated in sterling
- US Treasuries are issued by the Bureau of the Public Debt

Asia

(AA-/A2)

Issued By: Ministry of Finance (MoF)
- Japanese Government Bonds (JGBs)
- Revenue Bonds/Straight Bonds
- Financing Bills
- Subsidy Bonds
- Subscription Bonds
- Contribution Bonds
- Demand Bonds (kofu kokusai) [http://www.mof.go.jp/english/ Ministry of Finance]

Europe

Eurozone

(AAA/Aaa)

Issued By: Agence France Trésor, the French Debt Agency
- OATs
- BTFs - bills
- BTANs - 1 to 6 year notes
- Obligations assimilables du Trésor (OATs) -
- TEC10 OATs - floating rate bonds indexed on constant 10year maturity OAT yields
- OATi - French inflation-indexed bonds
- OAT€i - Eurozone inflation-indexed bonds [http://www.aft.gouv.fr Agence France Trésor]

(AAA/Aaa)

Issued By: Finanzagentur GmbH, the German Finance Agency
- Bunds
- Bubill - bills
- Bundesschatzanweisungen (Schätze) - 2 year notes
- Bundesobligationen (Bobls) - 5 year notes
- Bundesanleihen (Bunds) - bonds [http://www.deutsche-finanzagentur.de/ Finanzagentur GmbH]

(AA- "with negative outlook"/Aa2)

Issued By: Dipartimento del Tesoro
- BTPs
- Buoni Ordinari del Tesoro (BOTs) - bills up to 1 year
- Certificati del Tesoro Zero Coupon (CTZ) - bills up to 2 year
- Buoni del Tesoro Polianuali (BTPs) - bonds
- Certificati di Credito del Tesoro (CCTs) - floating rate notes
- BTP Indicizzato all'Inflazione - inflation linked bonds [http://www.dt.tesoro.it/ENGLISH-VE/Public-Deb/index.htm Dipartimento del Tesoro]

(AAA/Aaa)

Issued By: UK Debt Management Office
- Gilts
- Conventional Gilts
- Index-linked Gilts
- Double-Dated Gilts
- Undated Gilts
- Gilt Strips [http://www.dmo.gov.uk/ UK Debt Management Office]

North America

(AAA/Aaa)

Issued By: Bureau of the Public Debt
- US Treasuries
- Treasury bill
- Treasury note
- Treasury bond
- TIPS
- Savings bond [http://www.publicdebt.treas.gov/ Bureau of the Public Debt] Category:Bonds ja:国債

Seignorage

Seigniorage, also spelled seignorage or seigneurage, is the net revenue derived from the issuing of currency. It arises from the difference between the face value of a coin or bank note and the cost of producing and distributing it. Seigniorage is an important source of revenue for some national governments. For example, after the "50 State" series of Quarters was launched in the US in the late 1990s, the US government discovered that a large number of people were collecting each new quarter as it rolled out of the U.S. Mint, taking the pieces out of circulation. Since it costs the Mint less than five cents for each 25-cent piece it produces, the government made money whenever someone "bought" a coin and chose not to spend it. The US Treasury estimates that it has earned about $5 billion in seignorage profits from the quarters so far (April 2005). Seigniorage can also refer to a form of tax levied on the holders of a currency, and as such a redistribution of resources to the issuer. The expansion of the monetary base usually causes inflation in the long run. This means that the real wealth of people who hold cash or deposits decreases, and the real wealth of the issuer of the money increases. This is a redistribution of wealth from the people to the issuers (mostly banks) very similar to a tax. Banks relying heavily on seigniorage and fractional reserve as a source of revenue will find it counterproductive. Expectations of inflation will begin to take into account the bank's seignorage strategy, leading to hyperinflation, which causes significant real damage to the economy. Instead of cashing seigniorage from fiat money and credit most governments opt to raise revenue primarily by other means of taxation, which does additionally increase the poor-rich gap. The central banks hide the seigniorage revenue by writing it in the liability side of the balance, which is of course unlawful until detected. This book-cooking practice is done to avoid paying taxes on the monetary revenues, leaving the tax burden to the unsuspecting citizen (strawman).

Capital market

The capital market is the market for securities, where companies and the government can raise long-term funds. The capital market includes the stock market and the bond market. Financial regulators, such as the U.S. Securities and Exchange Commission and the Financial Services Authority in the UK, oversee the markets, to ensure that investors are protected against misselling. The capital markets consist of the primary market, where new issues are distributed to investors, and the secondary market, where existing securities are traded. The capital market can be contrasted with other financial markets such as the money market which deals in short term liquid assets, and derivatives markets which deals in derivative contracts.

Bond

---- In finance, a bond is a debt security, that is the issuer owes the holders a debt and is obliged to pay the principal and interest (the coupon), together with other obligations under the term of the issue, such as the obligation to give certain information. Bonds are generally issued for a fixed term (the maturity) longer than one year. A bond is just a loan, but in the form of a security, although terminology used is rather different. The issuer is equivalent to the borrower, the bond holder to the lender and the coupon to the interest. Debt securities with a maturity shorter than one year are typically bills, certificates of deposit or commercial paper, and considered money market instruments. Traditionally, the U.S. Treasury uses the word bond only for their issues with a maturity longer than ten years, and calls issues between one and ten year notes. Elsewhere in the market this distinction has disappeared, and both bonds and notes are used irrespective of the maturity. Market participants use bonds normally for large issues offered to a wide public, and notes rather for smaller issues originally sold to a limited number of investors. There are no clear demarcations. Bonds and stocks are both securities, but the difference is that stock holders own a part of the issuing company (have an equity stake), whereas bond holders are in essence lenders to the issuer. Also bonds have a definite lifespan, their maturity, whereas stocks may be held indefinitely. An exception is a console bond, which is a perpetuity.

Issuers

The range of issuers of bonds is very large. Almost any organization could issue bonds, but the underwriting and legal costs can be prohibitive. Regulations to issue bonds are very strict. Issuers are often classified as follows:
- Supranational agencies, such as the European Investment Bank or the Asian Development Bank issue Supranational bonds.
- National Governments issue Government bonds in their own currency. These are often called risk-free bonds. They also issue sovereign bonds in foreign currencies.
- Provincial, state or local authorities (municipalities). In the U.S. they issue what are known as municipal bonds
- Government sponsored entities in the U.S., such as the Federal Home Loan Mortgage Corporation (Freddie Mac) issue Agency bonds, commonly known as Agencies.
- Companies (corporates) issue Corporate bonds.
- Special purpose vehicles are companies set up for the sole purpose of containing assets against which bonds are issued, often asset-backed securities

Issuing bonds

Bonds are issued by governments or other public authorities, credit institutions, companies and supranational institutions in the primary markets. The most common process of issuing bonds is through underwriting. One or more banks, forming a syndicate, underwrite the bonds, and sell them on to their customers. Government bonds are typically auctioned. Bonds enable the issuer to finance long-term investments with external funds.

Features of bonds

The most important features of a bond are:
- nominal, principal or face amount - the amount over which the issuer pays interest, and which has to be repaid at the end.
- issue price - the price at which investors buy the bonds when they are first issued. The net proceeds that the issuer receives, are calculated as the issue price, less the fees for the underwriters, times the nominal amount.
- maturity date - the date on which the issuer has to repay the nominal amount. After the maturity date the issuer has no more obligations to the bond holders, as long as all payments have been made of course. The length of time until the maturity date is often referred to as the term or simply maturity of a bond. The maturity can be any length of time, although debt securities with a term of less than one year are generally designated money market instruments rather than bonds. Most bonds have a term of up to thirty years. Some bonds have been issued with maturities of up to one hundred years, and some even do not mature at all. These are called perpetuities. In early 2005, a market developed in euros for bonds with a maturity of fifty years. In the market for U.S. Treasury securities, there are three groups of bond maturities:
- short term (Bills): maturities up to one year
- medium term (Notes): maturities between one and ten years
- long term (Bonds): maturities greater than ten years
- coupon - the interest rate that the issuer pays to the bond holders. Usually this rate is fixed throughout the life of the bond. It can also vary with a money market index, such as LIBOR, or indeed it can be more exotic. The name coupon originates from the fact that in the past, physical bonds were issued which had coupons attached to them. On coupon dates the bond holder would give the coupon to a bank in exchange for the interest payment.
- coupon dates - the dates on which the issuer pays the coupon to the bond holders. In the U.S., most bonds are semi-annual, which means that they pay a coupon every six months. In Europe, most bonds are annual and pay only one coupon a year.
- callability - Some bonds give the issuer the right to repay the bond before the maturity date on the call dates. These bonds are referred to as callable bonds. Most callable bonds allow the issuer to repay the bond at par. With some bonds, the issuer has to pay a premium, the so called call premium. This is mainly the case for high-yield bonds. These have very strict covenants, restricting the issuer in its operations. To be free from these covenants, the issuer can repay the bonds early, but only at a high cost.
- puttability - Some bonds give the bond holder the right to force the issuer to repay the bond before the maturity date on the put dates.
- call dates and put dates - the dates on which callable and puttable bonds can be redeemed early. There are three main categories.
- A Bermudan callable has several call dates, usually coinciding with coupon dates.
- A European callable has only one call date. This is a special case of a Bermudan callable.
- An American callable can be called at any time until the maturity date.
- indenture - a document specifying the rights of bond holders. In the U.S. federal and state securities and commercial laws apply to the enforcement of those documents, which are construed by courts as contracts. The terms may be changed while the bonds are outstanding, but amendments to the governing document often require approval by a majority vote of the bond holders.

Types of bond

- Fixed rate bonds have a coupon that remains constant throughout the life of the bond.
- Floating rate notes (FRN's) have a coupon that is linked to a money market index, such as LIBOR or EURIBOR, for example three months USD LIBOR +0.20%. The coupon is then reset periodically, normally every three months.
- Convertible bonds can be converted, on the maturity date, into another kind of security, usually common stock in the company that issued the bonds.
- High yield bonds are bonds that are rated below investment grade by the credit rating agencies. As these bonds are relatively risky, investors expect to earn a higher yield, hence the name high yield bonds. Those market participants that want to emphasize the risky nature of the bonds, also call them junk bonds.
- Zero coupon bonds do not pay any interest. They trade at a substantial discount from par. The bond holder receives the full principal amount on the maturity date. An example of zero coupon bonds are Series E savings bonds issued by the U.S. Government. Zero coupon bonds may be created from fixed rate bonds by financial institutions by "stripping off" the coupons. In other words, the coupons are separated from the final principal payment of the bond and traded independently.
- Inflation linked bonds, in which the principal amount is indexed to inflation. The interest rate is lower than for fixed rate bonds with a comparable maturity. However, as the principal amount grows, the payments increase with inflation. The government of the United Kingdom was the first to issue inflation linked Gilts in the 1980's. Treasury Inflation-Protected Securities (TIPS) and I-bonds are examples of inflation linked bonds issued by the U.S. Government.
- Asset-backed securities are bonds whose interest and principal payments are backed by underlying cash flows from other assets. Examples of asset-backed securities are mortgage-backed securities (MBS), collateralized mortgage obligations (CMO) and collateralized debt obligations (CDO).
- Subordinated bonds are those that have a lower priority than other bonds of the issuer in case of liquidation. In case of bankruptcy, there is a hierarchy of creditors. First the liquidator is paid, then government taxes, etc. The first bond holders in line to be paid are those holding what is called senior bonds. After they have been paid, the subordinated bond holders are paid. As the expectation that you get paid back is lower, the risk is higher. Therefore, subordinated bonds have a lower credit rating then senior bonds. The main examples of subordinated bonds can be found in bonds issued by banks, and asset-backed securities. The latter are often issued in tranches. The senior tranches get paid back first, the subordinated tranches later.
- Perpetual bonds are also often called perpetuities. They have no maturity date. The most famous of these are the UK Consols, which are also known as Treasury Annuities or Undated Treasuries. Some of these were issued back in 1888 and still trade today.

Trading and valuing bonds

The interest rate that the issuer of a bond must pay is influenced by a variety of factors, such as current market interest rates, the length of the term and the credit worthiness of the issuer. Since these factors are likely to change over time, the market value of a bond can vary after it is issued. Because of these differences in market value, bonds are priced in terms of percentage of par value. Bonds are not necessarily issued at par (100% of face value), but all bonds will trade at par at the moment before they reach maturity. At other times, prices can either rise (bond is priced at greater than 100), which is called trading at a premium, or fall (bond is priced at less than 100), which is called trading at a discount. Most government bonds are denominated in units of $1000, if in the United States, or in units of one hundred pounds, if in the United Kingdom. Hence, a deep discount US bond, selling at a price of 75.26, indicates a selling price of $752.60 per bond sold. (Often, bond prices are quoted in points and thirty seconds of a point, rather than in decimal form.) Some short-term bonds, such as the U.S. T-Bill, are always issued at a discount, and pay par amount at maturity rather than paying coupons. This is called a discount bond. The market price of a bond is the present value of all future interest and principal payments of the bond discounted at the bond's yield, or rate of return. The yield represents the current market interest rate for bonds with similar characteristics. The yield and price of a bond are inversely related so that when market interest rates rise, bond prices generally fall and vice versa. The market price of a bond may include the accrued interest since the last coupon date. (Some bond markets include accrued interest in the trading price and others add it on explicitly after trading.) The price including accrued interest is known as the "flat" or "tel quel price". (See also Accrual bond.) The interest rate adjusted for the current price of the bond is called the "current yield" or "earnings yield" (this is the nominal yield multiplied by the par value and divided by the price). Taking into account the expected capital gain or loss (the difference between the current price and the redemption value) gives the "redemption yield": roughly the current yield plus the capital gain (negative for loss) per year until redemption. The relationship between yield and maturity for otherwise identical bonds is called a yield curve.

See

- Bond valuation

Investing in bonds

Bonds are bought and traded mostly by institutions like pension funds, insurance companies and banks. Most individuals who want to own bonds do so through mutual funds. Still, in the U.S., nearly ten percent of all bonds outstanding are held directly by households. Bonds are generally viewed as safer investments than stocks, but this perception is only partially correct. Bonds do suffer from less day-to-day volatility than stocks, and bonds' interest payments are higher than dividend payments that the same company would generally choose to pay to its stockholders. Bonds are liquid — it is fairly easy to sell one's bond investments, though not nearly as easy as it is to sell stocks — and the certainty of a fixed interest payment twice per year is attractive. Bondholders also enjoy a measure of legal protection: under the law of most countries, if a company goes bankrupt, its bondholders will often receive some money back, whereas the company's stock often ends up valueless. However, bonds can be risky:
- Fixed rate bonds are subject to interest rate risk, meaning they will decrease in value when the generally prevailing interest rate rises (the opposite is true for bonds with negative convexity e.g bonds that allow for prepayment such as mortgage-backed securities). When the market's interest rates rise, then the market price for bonds will fall, reflecting investors' improved ability to get a good interest rate for their money elsewhere — perhaps by purchasing a newly issued bond that already features the newly higher interest rate. This drop in the bond's market price does not affect the interest payments to the bondholder at all, so long-term investors need not worry about price swings in their bonds. However, price changes in a bond immediately affect mutual funds that hold these bonds. Many institutional investors have to "mark to market" their trading books at the end of every day. If the value of the bonds held in a trading portfolio has fallen over the day, the "mark to market" value of the portfolio may also have fallen. This can be damaging for professional investors such as banks, insurance companies, pension funds and asset managers. If there is any chance a holder of individual bonds may need to sell his bonds and "cash out" for some reason, interest rate risk could become a real problem. (Conversely, bonds' market prices would increase if the prevailing interest rate were to drop, as it did from 2001 through 2003.) One way to quantify the interest rate risk on a bond is in terms of its duration.
- Bonds prices can become volatile if one of the credit rating agencies like Standard & Poor's or Moody's upgrades or downgrades the credit rating of the issuer. A downgrade can cause the market price of the bond to fall. As with interest rate risk, this risk does not affect the bond's interest payments, but puts at risk the market price, which affects mutual funds holding these bonds, and holders of individual bonds who may have to sell them.
- A company's bondholders may lose much or all their money if the company goes bankrupt. Under the laws of the United States and many other countries, bondholders are in line to receive the proceeds of the sale of the assets of a liquidated company ahead of some other creditors. Bank lenders, deposit holders (in the case of a deposit taking institution such as a bank) and trade creditors may take precedence. There is no guarantee of how much money will remain to repay bondholders. As an example, after an accounting scandal and a Chapter 11 bankruptcy at the giant telecommunications company Worldcom, in 2004 its bondholders ended up being paid 35.7 cents on the dollar. In a bankruptcy involving reorganization or recapitalization, as opposed to liquidation, bondholders may end up having the value of their bonds reduced, often through an exchange for a smaller number of newly issued bonds.
- Some bonds are callable, meaning that even though the company has agreed to make payments plus interest towards the debt for a certain period of time, the company can choose to pay off the bond early. This creates reinvestment risk, meaning the investor is forced to find a new place for his money, and the investor might not be able to find as good a deal, especially because this usually happens when interest rates are falling.

Arguments against bonds

Some theories of economics, notably Islamic economics and green economics, argue that the overall effect of any debt on ecosystems and society is so negative that no bond should have any legal status. These theories are part of a broader category called creditary economics. In these, there is no creditor, only a joint venture partner or investor. Remnants of this same belief still exist even today in Western finance and legal precedents, as seen in usury laws, mortgage laws, and also as seen in perpetual bonds. At the time of issue during the late Middle Ages, many perpetual bonds were sold not as debt instruments but rather as an income stream or

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