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Using Economic Indicators for Fiscal Policy Decision Making • Leading Indicators – Change before the Economy reacts • Co-incident Indicators – Changes with the Economy and Business Cycles. • Lagging Indicators – Change after an event in the Economy Leading Indicators • • • • • • • Consumer Confidence CPI GDP Housing Starts Retail Sales Data PPI Employment Situation Coincident Indicators • Non-agricultural employment • Personal Income • Industrial Production Lagging Indicators • Change in CPI from previous month • Ratio of inventories to sales made • Ratio of consumer credit outstanding to personal income • Average prime rate charged by banks Deficits and Debt: Terminology and Facts • Budget Deficit = excess of a government’s expenditures over its receipts in a period of time • National Debt = total value of government indebtedness at a moment in time Deficits and Debt: Terminology and Facts • Some Facts about the National Debt – In absolute terms the debt is large, but as a proportion of GDP it is less than one half. – Some, but not all, is backed by government assets. – Before the 1980s, most of the debt was accumulated in times of war and recession. 31-3 The U.S. National Debt Relative to GDP, 1915-2001 FIGURE 1.00 Gross Domestic Product Ratio of Public Debt to 1981–1982 Recession World War II 0.67 Great Depression 1974–1975 Recession 0.50 World War I 0.33 1915 1925 1935 1945 1955 Year 1965 1975 1981–1984 Tax cuts 1993 Budget Agreement 1985 1995 Copyright © 2003 South-Western/Thomson Learning. All rights reserved. Interpreting the Budget Deficit or Surplus • Deficit rises in a recession and falls in a boom even with no change in fiscal policy. • Structural deficit (or surplus) = what the deficit (or surplus) would be at full employment – Portion of the deficit unrelated to the business cycle – Shows how the deficit is related to government policy Budget Deficits and Inflation • Deficits AD – Can cause inflation if economy is strong, since AS curves slope upward 31-6 The Inflationary Effects of Deficit Spending FIGURE D1 Aggregate supply curve shifts inward as wages rise Potential GDP D0 S 112 Price Level C 106 B 100 A D1 S D0 $5,000 $6,000 $7,000 Deficit spending boosts aggregate demand $8,000 Real GDP Copyright © 2003 South-Western/Thomson Learning. All rights reserved. Budget Deficits and Inflation • The Monetization Issue – If the Federal Reserve takes no countervailing actions, an expansionary fiscal policy that increases the budget deficit will tend to • real GDP and prices • Cause outward shift of the demand curve for money • interest rates FIGURE 31-7 Fiscal Expansion and Interest Rates M0 M1 S Interest Rate For given Fed policy B Shift in money demand caused by rising Y and P A M D0 D1 Quantity of Money Copyright © 2003 South-Western/Thomson Learning. All rights reserved. Budget Deficits and Inflation • The Monetization Issue – If the Fed does not want interest rates to rise • It can engage in expansionary open-market operations, that is, purchase more government debt. • The money supply will then increase. • The portion of the deficit purchased by the Fed has been monetized.