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Module 30
Long-run Implications
of Fiscal Policy: Deficits
and the Public Debt
KRUGMAN'S
MACROECONOMICS for AP*
Margaret Ray and David Anderson
What you will learn
in this Module:
• Why governments calculate the cyclically
adjusted budget balance
• Why a large public debt may be a cause
for concern
• Why implicit liabilities of the government
are also a cause for concern
Web sites on budget deficit.
The Budget Balance
• Deficits
• Surpluses
• Good? Bad?
U.S. NATIONAL DEBT CLOCK
The Budget Balance as a
Measure of Fiscal Policy
• Sgov = T - G - Transfers
• Expansionary policies reduce budget balance
• Contractionary policies increase budget balance
• G has a greater impact than T or Transfers
• Changes in budget balance are often result, not
cause, of economic fluctuations
The Budget Balance as a
Measure of Fiscal Policy
Case 1: Recessionary Gap
Expansionary fiscal policy
is in order. 3 options:
•Cut taxes.
•Increase transfers.
•Increase government
spending.
The Budget Balance as a
Measure of Fiscal Policy
Case 2: Inflationary Gap.
Contractionary fiscal policy
is in order. 3 options:
•Increase taxes.
•Decrease transfers.
•Decrease government
spending.
The Business Cycle and the Cyclically
Adjusted Budget Balance
• Strong relationship between budget balance
and business cycle
Recessions
are the
shaded
areas
The Business Cycle and the Cyclically
Adjusted Budget Balance (Continued)
• Cyclically adjusted budget balance
The budget deficit
almost always rises
when the
unemployment rate
rises and falls when
the unemployment
rate falls.
Should the Budget Be Balanced?
What does
it mean to
have a
“cyclically
balanced
budget?”
• Political motivation for running deficits or
balancing the budget
• Economists argue against balanced budget
rule in favor of cyclically balanced budget
• Limits on deficits as a compromise
Deficits, Surpluses, and Debt
•When spending exceeds tax revenue, government
borrows
•Fiscal years
•Public Debt
Problems Posed by Rising
Government Debt
•Government competes with private sector
for investment funds
•Financial pressure on future budgets
•Possibility of Default
•Monetizing the Debt
•Cyclical budget
Deficits and Debt in Practice
•Debt-GDP Ratio
Implicit Liabilities
•Implicit Liabilities
•Social Security
•Demographics
•Medicare
•Medicaid
Figure 30.6 Future Demands on the Federal Budget
Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition
Copyright © 2011 by Worth Publishers
Figure 30.2 The U.S. Federal Budget Deficit and the Unemployment Rate
Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition
Copyright © 2011 by Worth Publishers
Figure 30.5 Japanese Deficits and Debt
Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition
Copyright © 2011 by Worth Publishers