In Monday’s Technician, Mr. Chase McLamb’s piece titled “Vote against the bond” encouraged North Carolina residents to vote down the bond referendum that could bring $2 billion of funds to the state. Part of the raised money will go into public schools, including NC State.
If Mr. McLamb’s argument is against the federal government issuing bonds, that is debatable depending on how the Federal Reserve interacts with the fiscal authority, the Treasury Department. To understand the nature of government budget and deficit, one has to understand how government finances its budget over many years, rather than one or two years.
At the federal level, three main components of government revenue are from taxes, issuing government backed securities (bonds) and printing money. Mr. McLamb is right in a sense that bonds are actually a type of loan that requires interest payment for every period of time. Simply put, it is like credit cards on which you have to pay back your personal debt each statement cycle. You might not want to make the full payment each time, but in that way you let your debt compound by the interest rate in the future periods. You end up paying more, but you won’t have perpetual debt because you have to pay it off by the end of your last day. Credit card companies won’t let you rest in peace unless you come clean with debit.
A brief difference between personal debt and federal government debt is that government debt can stay perpetually, given the conditions that the central bank prints money for the government to pay back its debt, at the cost of inflation or disinflation. Of course, the government is also assumed to exist perpetually. But for a local government that is not able to control money supply, it is able to run a balanced budget even with issuing bonds.
Economists Thomas Sargent and Neil Wallace wrote a scholarly paper “Some unpleasant monetarist arithmetic” in 1981 to show that Milton Friedman’s notion of expanding money growth leading to inflation has to be under specific assumptions. In a simple model, they illustrated that a government without the power to issue money has to run a balanced budget in present value sense. The “balanced budget” here does not mean that government revenue should be exactly equal to government spending for each fiscal year. It is impossible for any government or individual to do that.
All market participants might end up having savings or debt at a particular point of time. Sargent and Wallace’s point was that if the public has certain demand of government bonds and that demand has an upper bound, government without help from monetary authority cannot perpetually run debt. In some time, government is allowed to have debt, but in some other time, government must have surplus in order to balance the “lifetime” budget.
For state governments, their deficit has to be paid back by taxes eventually, with no federal government bailout. State governments might argue that they expect the economy will grow faster and generate more government revenue in the future to avoid a tax rate hike. Whether or not government spending can boost economic growth is another story for another day.
But state governments naturally face more constraint when it comes to fiscal deficit than the federal government. As long as the public does not have infinite demand for government bonds, government debt as a temporary financing instrument is acceptable.
The demand of bonds mainly depends on people’s preference over consumption and the reputation of a state or municipal government. Governments with terrible credit might not raise enough funds because investors fear its default. People who want to save and postpone their consumption would be in favor of government bonds since it is easy to liquefy and gives higher interest payment than many saving accounts.
My final thought: It is not necessary to fear debt at the local level; the worst situation is similar to Detroit, Michigan, which went to bankruptcy, leading residents to move out of the state. If the raised funds could be really used in higher education, then that might essentially give the economy a boost since the benefit of higher education will not be revealed until many years after.
