fiscal policy, deficits, and debt 13 mcgraw-hill/irwincopyright © 2012 by the mcgraw-hill...
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Fiscal Policy, Deficits, and Debt
13
McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
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Fiscal Policy
• Council of Economic Advisors (CEA)
• Deliberate changes in
• Government spending
• Taxes
• Designed to
• Achieve full-employment
• Control inflation
• Encourage economic growth
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Fiscal Policy
• Define:
• Budget deficit
• Budget surplus
• National, or public, debt
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Expansionary Fiscal Policy
• Increases AE, GDP, and employment
• Increase government spending
• Decrease taxes
• Combination of both
• Expansionary policy creates a deficit (G > Tax revenue)
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Equilibrium vs Full Employment
• Recessionary Expenditures Gap
• Amount that AE must increase to reach full-employment, eq. GDP
• Spending is too low at full-employment
• Use expansionary fiscal policy to increase AE
• Desirable to create a deficit
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Contractionary Fiscal Policy
• Decreases AE, GDP, and employment
• Decrease government spending
• Increase taxes
• Combination of both
• Contractionary policy creates a budget surplus (G < Tax revenue)
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Equilibrium vs Full Employment
• Inflationary Expenditures Gap
• Amount that AE must decrease to reach full-employment, eq. GDP
• Spending is too high at full-employment
• Use contractionary fiscal policy to decrease AE
• Desirable to create a surplus
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Policy Options: G or T?
• Expand the size of government
• Increase government spending
• Increase taxes
• Reduce the size of government
• Decrease taxes
• Decrease government spending
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Built-In Stability
• Automatic stabilizers
• Tax revenue varies directly with GDP
• Transfers vary inversely with GDP
•Automatically creating a surplus during inflation and a deficit during recession
• Reduces severity of business fluctuations
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Evaluating Fiscal Policy
• Use the cyclically adjusted budget to evaluate fiscal policy
• Removes impact of built-in stabilizers
• Size of deficit/surplus if the economy is at full-employment for the year
• Cyclically adjusted budget only changes when government changes fiscal policy
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Recent U.S. Fiscal Policy
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Fiscal Policy: The Great Recession
• Financial market problems began in 2007
• In 08 passed $152 billion stimulus consisting of tax breaks
• Most people saved or paid credit cards
• Not very expansionary
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Fiscal Policy: The Great Recession
• In 09 passed American Recovery & Reinvestment Act with $787 billion stimulus
• Decreased taxes for low/middle income
• No lump sum checks
• Increased spending on transportation, ed, and aid to state governments
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Budget Deficits and Projections
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Problems, Criticisms, & Complications
• Problems of Timing
• Recognition lag
• Administrative lag
• Operational lag
• Political considerations– political business cycle
• Future policy reversals
• Off-setting state and local finance
• Crowding-out effectLO4
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Problems, Criticisms, & Complications
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• Biggest criticism of fiscal policy is Crowding-Out Effect.
• Crowding-Out Effect – When government borrows money, demand for money increases, and interest rates rise, reducing (crowding-out) investment.– Offsets expansionary impacts of fiscal
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The U.S. Public Debt
• $16.4 trillion in 2012
• The accumulation of years of federal deficits and surpluses
• Owed to the holders of U.S. securities
• Caused by war, recession, and fiscal policy
• Video Debt
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The U.S. Public Debt
• GDP is income of a nation
• Larger income means a greater ability to carry a large debt
• Look at debt as percentage of GDP as better gauge
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The U.S. Public Debt
• Interest charges on debt
• Largest burden of the debt
• Must at least pay interest every year
• 2.3% of GDP in 2012
• When interest as a percent of GDP increases, must raise taxes
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The U.S. Public Debt
• False Concerns
• Bankruptcy
•Refinancing
•Taxation
• Burdening future generations
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The U.S. Public Debt
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The U.S. Public Debt
• 33% of debt is externally held debt – paying it back will decrease RGDP
• 67% of debt is internally held debt – paying it back will not reduce RGDP
• Debt is an asset as owners of debt and a liability as taxpayers
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The U.S. Public Debt
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Global Perspective
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Substantive Issues
• Income distribution
• Incentives
• Foreign-owned public debt
• Crowding-out effect revisited
• Future generations
• Public investment
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