Download Sec 6, Mod 30, 31 Deficits Inflation

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
The Budget Balance
• Deficits
• Surpluses
• Good? Bad?
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 Business Cycle and the Cyclically
Adjusted Budget Balance
• Strong relationship between budget balance
and business cycle
The Business Cycle and the Cyclically
Adjusted Budget Balance (Continued)
• Cyclically adjusted budget balance
Should the Budget Be Balanced?
• Political motivation for running deficits or
balancing the budget (deficits cater to voters)
• Economists argue against balanced budget
rule in favor of cyclically balanced budget
(automatic stabilizers would be compromised)
• Limits on deficits as a compromise
Deficits, Surpluses, and Debt
•When spending exceeds tax revenue, government
borrows (crowding out threatens investment)
(increasing payment to interest threatens future
budgets)
•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 (issuing of T-bonds)
•Cyclical budget
Deficits and Debt in Practice
•Debt-GDP Ratio
Implicit Liabilities
•Implicit Liabilities (spending promises made
by the gov, not included in debt statistics)
•Social Security
•Demographics (Baby boomers retiring—stop
paying taxes and start collecting beneftis)
•Medicare
•Medicaid
Module 31
Monetary
Policy and
the Interest Rate
•KRUGMAN'S
•MACROECONOMICS for AP*
Margaret Ray and David Anderson
What you will learn
in this Module:
• How the Federal Reserve implements
monetary policy, moving the interest rate
to affect aggregate output
• Why monetary policy is the main tool for
stabilizing the economy
Monetary Policy and the Interest
Rate: Targeting the Fed Funds Rate
Expansionary Monetary Policy
1) Open
Market
purchase
2) Lowers
the interest
rate
The Economy
3) Which
increases
demand for
money for
investment
The
Money
Market
Contractionary Monetary Policy
The
Money
Market
1) Open
Market
salse
3) Which
decreases
demand for
money for
investment
2) increases
the interest
rate
The Economy
Monetary Policy in Practice
• Fed policy and the output gap
• Taylor Rule (setting the Fed
Funds Rate that takes into
account both inflation rate and
output gap)
• Fed Funds Rate = 1 + (1.5 x
inflation rate) + (0.5 x output gap)
OR
• 1+(1.5 X π%)+(0.5 X Output Gap)
Stanford Economist, John Taylor
Inflation Targeting
• The Fed and Inflation (prefers inflation of about 2%)
• Inflation Targeting (used by “other” central banks—
more accountability and transparency—everyone
knows the goal and if the bank doesn’t succeed, it
comes under scrutiny)
• Inflation Targeting v. Taylor Rule (Infl Targ more
forward-looking than backward-looking as the Taylor
Rule)
• Inflation Targeting v. Fed discretion