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13
Fiscal Policy, Deficits, and Debt
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter Objectives
• Purposes, Tools, and
Limitations of Fiscal Policy
• Role of Built-In Stabilizers in
Moderating Business Cycles
• How the Standardized Budget
Reveals the Status of U.S.
Fiscal Policy
• The Size, Composition, and
Consequences of the U.S.
Public Debt
30-2
Fiscal Policy
• Council of Economic Advisers
(CEA)
• Discretionary fiscal policy
–Eliminate recessionary or
inflationary gap
–Countercyclical
• Nondiscretionary fiscal policy
–Passive or automatic
30-3
Fiscal Policy and the
AD-AS Model or AE
Model
• Expansionary Fiscal Policy
–Increased Government Spending
–Tax Reductions
–Some Combination of the Two
–Political considerations
• Budget Deficit
30-4
Expansionary Fiscal Policy
Recessions
Decrease
Aggregate
Demand
Price Level
$5 Billion
Additional
Spending
AS
Full $20 Billion
Increase in
Aggregate Demand
P1
AD1
AD2
$490
$510
Real Domestic Output, GDP
30-5
Equilibrium Versus
Full-Employment GDP
Recessionary Expenditure Gap
Aggregate Expenditures
(billions of dollars)
550
530
510
AE0
AE1
$5 Billion
Gap Yields
$20 Billion
GDP
Change
Recessionary
Expenditure
Gap = $5 Billion
490
Full
Employment
470
45°
490
510
530
Real GDP (billions of dollars)
30-6
Fiscal Policy and the
AD-AS Model
• Contractionary Fiscal Policy
–Decreased Government Spending
–Increased Taxes
–Some Combination of the Two
• Budget Surplus
• Policy Options: G or T?
• Political considerations
G 11.1
30-7
Contractionary Fiscal Policy
Reduce
Demand Pull
Inflation
$5 Billion
Initial Decrease
In Spending
Price Level
AS
Full $20 Billion
Decrease in
Aggregate Demand
P1
AD4
AD3
$510
$522
Real Domestic Output, GDP
30-8
Equilibrium Versus
Full-Employment GDP
Inflationary Expenditure Gap
AE2
Aggregate Expenditures
(billions of dollars)
550
530
AE0
Inflationary
Expenditure
Gap = $5 Billion
$5 Billion
Gap Yields
$20 Billion
GDP
Change
510
490
Full
Employment
470
45°
490
510
530
Real GDP (billions of dollars)
30-9
Built-In Stability
• Automatic stabilizers
–Taxes and transfers
• Economic importance
• Tax progressivity
–Progressive tax system
–Proportional tax system
–Regressive tax system
30-10
Built-In Stability
Government Expenses, G
and Tax Revenues, T
T
Surplus
G
Deficit
GDP1 GDP2
GDP3
Real Domestic Output, GDP
30-11
Evaluating Fiscal Policy
• Standardized budget
–Full-employment budget
•
•
•
•
Cyclical deficit
Recent U.S. fiscal policy
Budget deficits and projections
Social security considerations
30-12
Evaluating Fiscal Policy
• Is the fiscal policy…
• Expansionary?
• Neutral?
• Contractionary?
• Use the cyclically adjusted budget to
evaluate
LO3
13-13
Government Expenses, G
and Tax Revenues, T
Evaluating Fiscal Policy
T
Cyclical deficit
Fiscal policy
neutral
$500
$450
a
b
G
c
GDP2
GDP1
(Year 2)
(Year 1)
Real Domestic Output, GDP
30-14
Government Expenses, G
and Tax Revenues, T
Evaluating Fiscal Policy
Standardized deficit
Expansionary fiscal
policy
$500
d
e
$475
$450
$425
T1
T2
G
h
f
g
GDP4
GDP3
(Year 4)
(Year 3)
Real Domestic Output, GDP
30-15
Budget Balances as % of GDP
(1)
Year
(2)
Actual
Deficit (-) or
Surplus (+)
(3)
Standardized
Deficit (-) or
Surplus (+)
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
-4.5%
-3.8%
-2.9%
-2.2%
-1.4%
-0.3%
+0.8%
+1.4%
+2.5%
+1.3%
-1.5%
-3.4%
-3.5%
-2.6%
-1.9%
-1.3%
-2.9%
-2.9%
-2.1%
-2.0%
-1.2%
-1.0%
-0.4%
+0.1%
+1.1%
+1.0%
-1.2%
-2.5%
-2.4%
-1.9%
-1.8%
-1.4%
Source: Congressional Budget Office
30-16
Recent U.S. Fiscal Policy
Federal Deficits (-) and Surpluses (+) as Percentages of GDP, 2000-2009
(1)
Year
(2)
Actual
Deficit – or
Surplus +
(3)
Cyclically
Adjusted
Deficit – or
Surplus +*
2000
+2.4
+1.1
2001
+1.3
+0.5
2002
-1.5
-1.3
2003
-3.4
-2.7
2004
-3.5
-3.2
2005
-2.6
-2.5
2006
-1.9
-2.0
2007
-1.2
-1.2
2008
-3.2
-2.8
2009
-9.9
-7.3
•As a percentage of potential GDP
Source: Congressional Budget Office, http://www.cbo.gov.
LO3
13-17
Fiscal Policy: The Great Recession
• Financial market problems began in
•
•
•
LO4
2007
Credit market freeze
Pessimism spreads to the overall
economy
Recession officially began December
2007 and lasted 18 months
13-18
Global Perspective
LO4
13-19
Budget Deficits and Projections
Actual
Projected
(as of March 2010)
Budget Deficit (-) or Surplus, Billions
$200
0
-200
-400
-600
-800
-1000
-1200
-1400
-1600
1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014
Source: Congressional Budget Office, http://www.cbo.gov.
LO4
13-20
Fiscal Policy Issues
Problems, Criticisms, and Complications
• Problems of timing
– Recognition lag
– Administrative lag
– Operational lag
• Political considerations
– Political Business Cycle
– Annual balanced budgets
– Cyclically balanced budgets
• Future policy reversals
• Offsetting state and local finance
• Crowding-out effect
30-21
Current Thinking on Fiscal Policy
• Let the Federal Reserve handle short•
•
•
LO4
term fluctuations
Fiscal policy should be evaluated in
terms of long-term effects
Use tax cuts to enhance work effort,
investment, and innovation
Use government spending on public
capital projects
13-22
The U.S. Public Debt
• $11.9 trillion in 2009 ($9.01 Trillion 2007
•
LO4
and $7.96 Trillion in 2005)
• The accumulation of years of federal
deficits and surpluses
Owed to the holders of U.S. securities
• Treasury bills
• Treasury notes
• Treasury bonds
• U.S. savings bonds
13-23
The U.S. Public Debt
Debt held
outside
the Federal
government
and the
Federal
Reserve:
57%
LO4
Debt held by
the Federal
government
and the
Federal
Reserve:
43%
13-24
The U.S. Public Debt
LO4
13-25
Global Perspective
Public Sector Debt as
Percentage of GDP, 2009
0
20
40
60
80
100
Italy
Japan
Greece
Belgium
France
United States
France
Germany
United Kingdom
Spain
Netherlands
Canada
Source: Organization for Economic Cooperation and Development, OECD
LO4
13-26
The U.S. Public Debt
• Interest charges on debt
• Largest burden of the debt
• 1.3% of GDP in 2009
• False Concerns
• Bankruptcy
• Refinancing
• Taxation
• Burdening future generations
LO4
13-27
Debt and GDP
• Substantive issues
–Income distribution
–Incentives
–Foreign-owned public debt
• Crowding-out effect revisited
–Burden on future generations
–Public investment as an offset
–Graphically
30-28
Crowding Out
A Large Public Debt to Finance Public Investment Will Cause…
16
If Public Spending
Spurs More Private
Investment Will
Increase to ID2
Real Interest Rate (Percent)
14
12
b
10
c
8
a
6
Interest Rate
Rise Will
4
Decrease
2 Investment
a to b
0
5
10
CrowdingOut Effect
ID2
ID1
15
20
25
30
35
40
Investment (Billions of Dollars)
30-29
The Leading Indicators
1. Average workweek
2. Initial claims for unemployment
insurance
3. New orders for consumer goods
4. Vendor performance
5. New orders for capital goods
6. Building permits for houses
7. Stock prices
8. Money supply
9. Interest-rate spread
10. Consumer expectations
Source: The Conference Board
30-30
Social Security, Medicare Shortfalls
• More Americans will be receiving
•
•
benefits as they age
Social security shortfalls
• Income during retirement
• Funds will be depleted by 2037
Medicare shortfalls
• Medical care during retirement
• Funds will be depleted by 2017
13-31
Social Security, Medicare Shortfalls
• Possible options “to fix” include:
• Increasing the retirement age
• Increasing the portion of earnings
subject to the social security tax
• Disqualifying wealthy individuals
• Redirecting low-skilled immigrants
to higher-skilled, higher paying work
• Defined contribution plans owned
by individuals
13-32
Key Terms
• fiscal policy
• Council of Economic
Advisers (CEA)
• expansionary fiscal
policy
• budget deficit
• contractionary fiscal
policy
• budget surplus
• built-in stabilizer
• progressive tax system
• proportional tax system
•
•
•
•
•
•
•
•
•
regressive tax system
standardized budget
cyclical deficit
political business
cycle
crowding-out effect
public debt
U.S. securities
external public debt
public investments
30-33