Download 12-3

The Budget Balance
Chapter 12-3
Laugher Curve
• When Albert Einstein died, he met three
New Zealanders in the queue outside the
pearly gates.
• To pass the time, he asked what were
their IQs.
Laugher Curve
• The first replied 190.
• "Wonderful," exclaimed Einstein, "We can
discuss the contribution made by Earnest
Rutherford to atomic physics and my
theory of general relativity.”
Laugher Curve
• The second answered 150.
• "Good," said Einstein, "I look forward to
discussing the role of New Zealand's
nuclear-free legislation in the quest for
world peace.”
Laugher Curve
• The third New Zealander mumbled 50.
• Einstein paused, and then asked, "So what
is your forecast for the budget deficit next
year?"
The Budget Balance
How do surpluses and deficits fit into
the analysis of fiscal policy?
Are deficits ever a good thing and
surpluses a bad thing?
The Budget Balance as a
Measure of Fiscal Policy
The Budget Balance as
measure of Fiscal Policy
• Other things equal, discretionary
expansionary fiscal policies—increased
government purchases of goods and
services, higher government transfers, or
lower taxes—reduce the budget balance
for that year
The Budget Balance as
measure of Fiscal Policy*
• expansionary
fiscal policies
make a budget
surplus smaller or
a budget deficit
bigger.

Contractionary
fiscal policies
increase the budget
balance for that
year, making a
budget surplus
bigger or a budget
deficit smaller.
The Budget Balance as
measure of Fiscal Policy
This approach is sometimes misleading:
1. Different changes in Fiscal policy that
have equal effects on budget balance
may have unequal effect on Aggregate
Demand. (Effect of Taxes v.
Government spending
2. Often Budget Balance are the result of
fluctuation in the economy.
The Business Cycle and
Cyclically Adjusted Budget
Balance


Some of the fluctuations in the budget balance
are due to the effects of the business cycle.
In order to separate the effects of the business
cycle from the effects of discretionary fiscal
policy, governments estimate the cyclically
adjusted budget balance, an estimate of the
budget balance if the economy were at
potential output.
Automatic Stabilizers
•
During Expansions Tax Revenues Rise
and Unemployment Benefits (Transfer
Payment) Fall
S
•
Government
=T -G-TR
What do you think happens in a
Recession?
The Federal Budget Deficit & The Business
Cycle
The budget deficit as a percentage of GDP tends
to rise during recessions (indicated by shaded
areas) and fall during expansions.
The U.S. Federal Budget Deficit and the
Unemployment Rate
There is a close relationship between the budget balance and the
business cycle: A recession moves the budget balance toward
deficit, but an expansion moves it toward surplus.
The Actual Budget Deficit & Cyclically
Adjusted Budget Deficit
Balancing the Budget
Destabilize the Economy?
• State constitutional provisions mandating
balanced budgets act as automatic
destabilizers.
• These states cut spending and raise
taxes during recessions and increase
spending and cut taxes during
expansions.
Should the Budget be
Balanced?


Most economists don’t believe the
government should be forced to run a
balanced budget every year because this
would undermine the role of taxes and
transfers as automatic stabilizers.
Yet policy makers concerned about
excessive deficits sometimes feel that
rigid rules prohibiting—or at least setting
an upper limit on—deficits are necessary.