Debts come in different shapes and sizes. There’s private debt, corporate debt, and government debt. Among these, public debt is the largest and most important type of debt.
In this article, we’re going to take a close look at public debt and try to answer some common questions about it.
- Refunding, Converted Loans, Sinking Fund and Repudiation are some ways to repay debt.
- Public debt can lead to high levels of inflation and a decrease in the currency’s value.
- Careful usage of public debt contributes to stronger economic growth
What Is Public Debt?
Public debt is the entire amount, including total debt, of money that a national government has borrowed.
Also, Public debt is different from private debt, which consists of the debts of people, corporate entities, and nonprofit organizations.
Public debt is an important method of bridging the funding gaps of the government.
Careful usage of public debt contributes to stronger economic growth and adds to the ability to service and repay foreign and domestic debt. It also assists the government in attaining its social and community goals. 1
Gross External Debt VS. Public Debt
The Gross external debt and public debt are not the same. Gross external debt is the amount both the private sector and the government owe to foreign investors.
Even though public debt impacts external debt, they are not the same. If the interest rises for public debt, then it will also rise for private debt.
This is why businesses pressure the government to keep public debt at a limit. 2
How Much Public Debt Is Too Much?
Types Of Public Debt
Public debt can be classified into several types:
Internal And External Debts
Internal debt occurs when a government raises money by borrowing from within the country. If the government borrows from other countries, this is referred to as external debt.
Redeemable And Non-Redeemable Debts
Redeemable debts are those that the government promises to return at some point in the future (interest plus debt).
Irredeemable debts are ones for which the government never repays the principal but pays interest on a regular basis.
Funded And Unfunded Debts
Funded debt is debt that is owed for a long time or for a specific period of time.
There is a valid agreement, terms, and conditions of repayment, as well as the percentage of interest that must be paid. They are used in the creation of long-term assets.
Compulsory And Voluntary
Voluntary debt is a debt that is not enforced by the law. Compulsory debt, on the other hand, is a legally imposed obligation. People have no choice but to settle their debts in this situation. 3
Why Does The U.S. Keep Hitting the Debt Ceiling?
Methods Of Debt Repayment
There are four ways to repay debt. Here’s a look at each:
Repudiation refers to the act of refusing to recognize or pay a debt. It’s often used as a political tool to score points with voters.
The United States used this method after the Revolutionary War and the War of 1812. More recently, Ecuador defaulted on its debt in 2008.
This procedure is not recommended as it can lead to a loss of credibility and trust, making it difficult to borrow in the future.
Refunding is the process of replacing assets that are aging with new securities when they come onto the market.
Debts may be returned prior to the date on which they are scheduled to mature.
This method is often used by companies and governments to take advantage of lower interest rates.
It also allows them to extend the maturity date of the debt, giving them more time to repay.
This is not like any other kind of return. Before they reach their maturity date, aged securities are exchanged for brand-new securities.
One common strategy for reducing one’s overall debt burden is to refinance loans with high-interest rates into loans with lower interest rates.
A sinking fund is a special fund set up to pay off government debt. The creation of this fund has a theoretical validity in that it forces the government to pay off previous obligations on a regular basis.
This system requires the government to set aside a particular amount of money from the budget each year for this fund.
How To Calculate Public Debt?
To estimate public debt, simply add all budget deficits over the years you would like to measure.
This method does not include the cost of servicing debt, which is why some experts like to add liability categories like pensions, debt securities, etc., separately.
While public debt can be useful for governments, it’s important to use this tool carefully.
If not managed correctly, public debt can lead to high levels of inflation and a decrease in the currency’s value.
It can also cause a country to default on its debt, which can have devastating consequences.
How did the national debt get so big?
Over the years, the government has been increasing the amount it spends at a faster rate than its earnings, especially on national security, medicare, social security, etc.
The increase in debt is causing a snowball effect, and this, along with interest rate and inflation, has caused the increase in national debt.
Can the government not print more money to get out of debt?
Printing money is in the hand of the federal reserve and not the federal government.
Printing more money will only lead to more inflation unless there is enough economic activity to adjust the amount of money created. 4
What are the examples of public debt?
Government employee pension obligations, loans, debt securities (like bills and bonds), etc. are examples of public debt.
Amit Gupta is the founder of National Planning Cycles, a company that helps startups, individuals, and small businesses with their financial planning. He has a vast amount of experience in the finance sector, having managed Google Play accounts for some of the world’s most successful unicorns. Amit is an expert in his field, and he uses his knowledge to help others achieve their individual goals.
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