FISCAL POLICY, DEFICITS AND DEBT

Pertemuan 9

Matakuliah : J0594-Teori EkonomiTahun : 2009

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Fiscal Policy and the AD-AS Model

• Expansionary Fiscal PolicyIncreased Government SpendingTax ReductionsSome Combination of the Two

• Contractionary Fiscal Policy– Decreased Government Spending– Increased Taxes– Some Combination of the Two

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Fiscal Policy and the AD-AS Model

Real Domestic Output, GDP

Pri

ce L

evel

AD3

RecessionsDecreaseAggregateDemand

AD4

$5 Billion Initial Decrease

In Spending

Full $20 Billion Decrease in

Aggregate Demand

AS

$510 $522

P1

Contractionary Fiscal Policy

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Fiscal Policy and the AD-AS Model

Real Domestic Output, GDP

Pri

ce L

evel

AD2

RecessionsDecreaseAggregateDemand

AD1

$5 Billion AdditionalSpending

Full $20 Billion Increase in

Aggregate Demand

AS

$490 $510

P1

Expansionary Fiscal Policy

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Built-In Stability

• Economic Importance• Tax Progressivity• Automatic or Built-In Stabilizers

– Progressive Tax System– Proportional Tax System– Regressive Tax System

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Built-In Stability

G

T

Deficit

Surplus

GDP1 GDP2 GDP3

Real Domestic Output, GDP

Go

vern

men

t E

xpen

ses,

Gan

d T

ax R

even

ues

, T

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Evaluating Fiscal Policy

• Standardized Budget (Full-Employment Budget)

• Cyclical Deficit• Recent U.S. Fiscal Policy• Budget Deficits and Projections• Social Security Considerations

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Evaluating Fiscal Policy

G

T

GDP2 GDP1

Real Domestic Output, GDP

Go

vern

men

t E

xpen

ses,

Gan

d T

ax R

even

ues

, T

(Year 2) (Year 1)

$500

$450

ab

c

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Evaluating Fiscal Policy

G

T1

GDP4 GDP3

Real Domestic Output, GDP

Go

vern

men

t E

xpen

ses,

Gan

d T

ax R

even

ues

, T

(Year 4) (Year 3)

$500

$450

de

f

$475

$425 g

T2

h

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The Public Debt

• National or Public Debt $7.96 Trillion• Ownership

– U.S. Securities– 42% Owned by Federal Government and

Federal Reserve– 58% Held Outside the Federal

Government and Federal ReserveGraphically…

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The Public Debt

Debt Held by theFederal Government

and FederalReserve (51%)

Debt Held OutsideThe FederalGovernmentand Federal

Reserve (49%)

FederalReserve

U.S.Government

AgenciesU.S.Individuals

ForeignOwnership

U.S. BanksAnd otherFinancial

Institutions

Other – IncludingState and LocalGovernments

Source: U.S. Treasury

9%

8%

25%

8% 8%

42%

Total Debt$7.96 Trillion

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Debt and GDP

• Interest Charges• False Concerns

– Bankruptcy– Refinancing– Taxation– Burdening Future Generations

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Debt and GDP• Substantive Issues

– Income Distribution– Incentives– Foreign-Owned Public Debt– Crowding-Out Effect Revisited

Graphically…

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Debt and GDPThe Investment Demand Curve and the Crowding-Out Effect

5 10 15 20 25 30 35 400

2

4

6

8

10

12

14

16

Rea

l In

tere

st R

ate

(P

erce

nt)

Investment Demand (Billions of Dollars)

ID1

ID2

a

b c

Interest RateRise WillDecrease

Investmenta to b

Crowding-Out Effect

A Large Public Debt to Finance Public Investment Will Cause…

If Public SpendingSpurs More Private

Investment WillIncrease to ID2

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Debt and GDP

• Public Investments and Public-Private Complementarities

• Public Investments– Public Goods Spending– Human Capital Spending– Reduction on Crowding-Out Effect