Chapter 21Financial Effects of

the Government and Foreign Sectors

©2000 South-Western College Publishing

2

Fiscal PolicyGovernment spending and taxing decisions to speed up or slow down the level of economic activity

3

Aggregate DemandThe total quantity of final goods and services that will be demanded at various prices, including •consumption•investment•government purchases of goods and services

4

Aggregate Supply

The total quantity of final goods and services that will be supplied at various prices

5

Public Debt

The sum of all past government deficits less past surpluses

6

Government Outlays – Government Receipts = New Borrowing

= Net New Debt Issued by the Treasury (bills,

notes, and bonds) = Net Government Demand for Loanable Funds

( Eq.21.1)

7

Rolled Over means...

Borrowing to pay off maturing debt

8

Refunding

The refinancing of past government debt that is maturing

9

The Difference Between Federal Outlays and Federal Receipts (billions)

Year Receipts Outlays + or -1960 $92.5 $92.2 $.31965 116.18 118.2 -1.41970 192.8 195.6 -2.81975 279.1 332.3 -53.201980 517.1 590.9 -73.81985 734.1 946.4 -212.31990 1,031.3 1,252.7 -221.41995 1,463.2 1,637.1 -174.41996 1,587.6 1,698.1 -110.41997 1,723.4 1,752.2 -28.81998 1,721.8 1,652.5 48.9*

Exhibit 21 -1 * First Quarter only

10

Exhibit 21 -2

2000

1500

1000

500

ReceiptsOutlaysB

illi

ons

of d

olla

rs

The Difference Between Federal Outlays & Receipts

199819751970 1980 1985 1990 1995

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Regularized

The advanced announcements of Treasury

intentions to borrow at standard intervals

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Federal Outlays & Receipts as a Percentage of GDPYear Receipts Outlays Difference1960 18.3% 18.3% 0%1965 7.4 17.6 -.21970 19.6 19.9 -.31975 18.5 22.0 -3.51980 19.6 22.3 -2.71985 18.5 23.9 -5.41990 18.8 22.9 -4.11995 20.1 22.5 -2.41996 20.7 22.2 -1.51997 21.3 21.7 -.41998 19.8 19.0 .8*

* first quarter onlyExhibit 21 - 3

13

19981975

Exhibit 21 - 4

1970 1980 1985 1990 1995

22%

20%

18%

16%

0%

24%Federal Outlays & Receipts as a Share of GDP

ReceiptsOutlays

14

To whom the Federal Debt is Owed, as of June 30, 1998

billions %Domestic Investors $ 2,068 37%U.S. Government Agencies 1,827 32Foreign Investors 1,276 23Federal Reserve Banks 472 8Total National Debt $ 5,643 100%

Exhibit 21 -5

15

Crowding Out

The reduction in private borrowing and spending due to higher interest rates that result from government deficit financing

16

Interest Rate (%)

6

The Effect of a Rise in Government Borrowing

Exhibit 21 - 6

8

A

DD

D'D'

$500 $530 $550Loanable Funds (billions)

B

S

17

Interest Rate (%)

4

The Effect of a Reduction in Government Borrowing

Exhibit 21 - 7

6 A

DDD'D'

$450 $480 $500

Loanable Funds (billions)

S

B

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Sources of Funds Uses of Funds

Tax Receipts + Borrowing = Government spending on goods

and services

+ Government spending on transfer

payments

+ Interest payments on the public debt

+ Changes in financial assets held

(Eq. 21.2)

19

Sources of Funds Uses of Funds

Tax Receipts +

Net Borrowing = Government spending on goods and services

+ Government spending on transfer

payments

+ Interest payments on the public

debt

(Eq. 21.3)

20

Monetized

When the Fed purchases newly issued Treasury securities, that credits the Treasury’s deposit account

21Exhibit 21 -8

12.0

9.0

6.0

3.0

Exports

Imports

15.0

19981985 1995

Exports and Imports Relative to Gross Domestic Product

1990198019751970

Per

cen

t of

GD

P

Year

22

Net Capital Inflow occurs...

…when the purchases of U.S. financial claims by foreigners exceed purchases of foreign financial claims by U.S. entities

23

Net Capital Outflow occurs...

…when the purchases of foreign financial claims by U.S. entities exceed the purchases of U.S. financial claims by foreigners

24

Exhibit 21 - 9

-2.0

-2.5

-3.0

-3.5

-1.5

Cap

ital

Flo

ws/

GD

P(

%)

-1.0

-0.5

0.0

0.5

1.0

1.5Capital Flows Relative to GDP

1970 1975 1980 1985 1990 1995 1998

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Twin Deficits

During the 1980’s, •the high trade deficit and •the high government deficit

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Exhibit 21 - 10

-150

-200

-250

-300

-100

Cap

ital

Flo

ws/

GD

P(

%)

-50

0

50Capital Flows Relative to GDP

Federal Government Balance

Trade Balance

1970 1975 1980 1985 1990 1995 1998

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Sources Foreign Exchange Uses Foreign Exchange

Foreign purchases of U.S. purchases of U.S. goods and services foreign goods & services

+ +Net transfers from Net transfers to

foreigners = foreigners

+ +Net foreign purchases Net U.S. purchases ofU.S. financial assets foreign financial assets

(Eq. 21.4)