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What Is the Public Debt?

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public debt

Public debt is what the government owes to external lenders.

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The public debt is defined as how much a country owes to lenders outside of itself. These can include individuals, businesses and even other governments. The term "public debt" is often used interchangeably with the term sovereign debt.

Public debt usually only refers to national debt, but some countries also include the debt owed by states, provinces and municipalities. Therefore, be careful when comparing public debt between countries to make sure the definitions are the same.

Regardless of what it's called, public debt is the accumulation of annual budget deficits. It's the result of years of government leaders spending more than they take in via tax revenues. For more, see How the Debt and Deficit Differ and Affect Each Other.

U.S. Public Debt:

The U.S. Treasury Department manages the U.S. debt through its Bureau of the Public Debt. It measures debt owned by the public separately from intragovernmental debt.

On October 17, 2013, the U.S. debt surpassed $17 trillion, and its debt-to-GDP ratio was more than 100%. However, the public debt was a more moderate $12.1 trillion, making the public debt-to-GDP ratio a safe 73%. Perhaps that's why investors did not insist on higher interest rates. In fact, interest rates were historically low. To understand why, see U.S. Debt Crisis.

Public Debt vs External Debt:

Don't confuse public debt with external debt, which is the amount owed to foreign investors by both the government and the private sector. Public debt affects external debt, because if interest rates go up on the public debt, they will also rise for all private debt. Therefore, businesses usually put pressure on governments to keep public debt within a reasonable range. (Source: CIA World Factbook Glossary Public Debt)

When Public Debt Is Good:

In the short run, public debt is a good way for countries to get extra funds to invest in their economic growth. Public debt is a way for foreigners to invest in a country's growth by buying government bonds. This is usually safer than foreign direct investment, which is when foreigners purchase at least a 10% interest in the country's companies, businesses or real estate. It's also less risky than investing in the country's public companies via its stock market. Public debt is attractive to risk-averse investors, since it is backed by the government itself.

When used correctly, public debt improves the standard of living in a country. That's because it allows the government to build new roads and bridges, improve education and job training, and provide pensions. This spurs citizens to spend more now, instead of saving for retirement, further boosting economic growth.

When Public Debt Is Bad:

However, governments have a tendency to take on too much debt because the benefits make them popular with voters. Therefore, investors usually measure the level of risk by comparing debt to a country's total economic output, known as Gross Domestic Product (GDP). The debt-to-GDP ratio gives an indication of how likely the country can pay off its debt. Investors usually don't become concerned until the debt-to-GDP ratio reaches a critical level. That's usually 90% for developed countries, and 70% for emerging market countries.

When it appears the debt is approaching a critical level, investors usually start demanding a higher interest rate. They want more return for the higher risk. If the country keeps spending, then its bonds may receive a lower S&P rating. This indicates how likely it is the country will default on its debt. As interest rates rise, it becomes more expensive for a country to refinance its existing debt. In time, more income has to go toward debt repayment, and less toward government services. For more on how this has actually occurred in Europe, see Sovereign Debt Crisis.

In the long run, public debt that's too large can act like driving with the emergency brake on. Investors drive up interest rates, which makes the drivers of economic expansion (housing, business growth and auto loans) more expensive. To avoid this burden, governments must be careful to find that sweet spot of public debt -- large enough to drive economic growth, but small enough to keep interest rates low. Article updated October 22, 2013

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