Conflict over the federal budget seems to be never-ending. But the terms used in these discussions are not always clear. For example, how does the federal debt differ from the federal deficit? What does it mean for debt to be "monetized"? The following defines some of the key terms and concepts used in discussions about the federal budget:
The deficit vs. the national debt: The debt and the deficit are not the same thing. The budget deficit is the difference between what the government spends on goods, services and interest payments and what it collects in taxes (net of cash transfers to the public). A negative deficit -- when spending amounts to less than tax collections -- is known as a surplus and has been rare in recent decades. The national debt is the sum of all past surpluses and deficits. The deficit for 2013 was $679.5 billion, while the national debt was $16,719.4 billion.
Public debt vs. private debt: The figure of $16,719.4 billion given above for the national debt includes so-called interagency debt -- that's when one branch of the government owes another branch money. The private debt, a measure that strips out all interagency debt, is currently $11,982.6 billion. For many purposes, the private debt is a much better measure of the government's obligations. When one branch of the government pays another, no private debt -- and hence no new obligations on the public -- are created. But it's not always the best measure. For example, some of the interagency debt is from the Social Security trust fund. In order to make good on its obligations in the trust fund, the government will need to issue new debt to the public, and that will transfer some of the interagency debt to private debt. Thus, to the extent that the government will have to borrow to make good on trust fund promises, the actual amount of the government's obligations exceeds the private debt.
Treasury bills vs. Treasury notes vs. Treasury bonds: The distinction between Treasury bills, notes and bonds is simply the length of time until the bond matures. T-bills mature in one year or less, T-notes from two to 10 years, while T-bonds have a maturity of 20 to 30 years.
Treasury Inflation-Protected Securities: Bonds pay a fixed amount -- for example, $10 per year on a $100 year bond for a return of 10 percent. Because the payments are fixed, inflation can lower the real value of those payments by eroding the purchasing power of the payments the bond offers. TIPS, which come in maturities of 5, 10 and 30 years, have payments that are indexed for inflation and thus avoid this risk.
Government budget constraint and debt monetization: There are two ways to finance a deficit. The first is to issue government debt, or borrow from the public to pay for the difference between spending and taxes (issue T-bills, T-notes or T-bonds). The second is to print new money and use it to pay for the goods and services the government purchased in excess of the taxes it collected. The relationship among these quantities -- that the deficit (government spending minus taxes) must equal new debt issues plus new money creation -- is called the government budget constraint. When the government first issues new debt to pay for a deficit, and then the Federal Reserve buys that debt with newly printed money (as it does when it performs open market operations or quantitative easing), we say the debt has been monetized.