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Contemporary Economics:
An Applications Approach
By Robert J. Carbaugh
1st Edition
Chapter 13:
Fiscal Policy and the Federal
Budget
Copyright ©2001, South-Western College Publishing
Fiscal Policy
Price level (price index)
Expansionary fiscal policy
130
120
115
110
105
100
Increase
in output
AS0
125
A
95
AD0
AD1
90
85
650
700
Full
employment
output
B
750
800
850
900
950
Real output ($ bill.)
Carbaugh, Chap. 13
2
Fiscal Policy
Price level (price index)
Expansionary fiscal policy and the multiplier
130
125
Direct effect of
an increase in
government
spending
Indirect effect
of increased AS
0
consumption
spending
120
115
110
105
100
B
A
C
95
AD2
90
85
650
AD1
AD0
700
750
800
850
900
950
Real output ($ bill.)
Carbaugh, Chap. 13
3
Fiscal Policy
Price level (price index)
Contractionary fiscal policy
140
Fall in
price level
AS0
130
B
120
A
110
100
90
100
AD1
AD0
Fall in
price level
Full
employment
900 1,100
Real output ($ bill.)
Carbaugh, Chap. 13
4
Fiscal Policy
Crowding-out effect
Government spending
exceeds taxes, resulting
in a budget deficit.
The government enters
the loanable funds market
and issues more securities.
Carbaugh, Chap. 13
As the demand for loanable
funds rises, interest
rates increase.
Firms and households
purchase less machinery,
equipment, autos, and homes.
Thus government spending
crowds out private
sector spending.
5
Fiscal Policy
120
The goal of supply-side
tax cuts
Fall in
prices
AS0
Price level (price index)
Price level (price index)
Supply-side fiscal policy
AS1
110
100
A
B
90
130
A more dismal view of
supply-side tax cuts
AS0
AS1
120
B
110
A
100
AD1
90
80
AD0
80
AD0
Increase in
real output
70
500
700
900
1100
1300
Real output (billion dollars)
Carbaugh, Chap. 13
1500
70
500
700
900
1100
1300
1500
Real output (billion dollars)
6
Fiscal Policy
Tax revenue ($ billions)
The Laffer Curve
400
A
300
B
200
100
0
0
48
85
100
Tax rate (%)
Carbaugh, Chap. 13
7
Federal Deficit
Federal debt held by the public
Year
Federal
debt (bill.)
GDP
Federal debt as
(billions)
a % of GDP
1940
1945
1950
1955
1960
1965
1970
1975
1980
1985
1990
1995
1998
$42.8
235.2
219.0
226.6
236.8
260.8
283.2
394.7
709.8
1,499.9
2,410.7
3,603.4
3,719.9
$96.5
221.4
273.6
395.3
518.2
686.7
1,009.0
1,554.5
2,718.9
4,102.1
5,684.5
7,194.8
8,537.9
44.3%
106.2
80.1
57.3
45.7
38.0
28.1
25.4
26.1
36.6
42.4
50.1
43.6
Source: Economic Report of the President, 1999
Carbaugh, Chap. 13
8
Government Debt
Government debt to GDP ratios for selected countries, 1997
Country
Government debt as
a percent of GDP
Belgium
Italy
Hungary
Sweden
Finland
United States
France
Japan
India
Germany
126
94
72
70
69
46
46
45
44
39
Source: IMF, International Financial Statistics, March 1999
Carbaugh, Chap. 13
9
Federal Debt
Ownership of federal debt, 1998
Private
investors:
individuals,
banks,
insurance
companies,
etc.
38%
Federal
Reserve
Banks
8% 1999
Source: Federal Reserve Bulletin, May
Carbaugh, Chap. 13
US Treasury
and other
Federal
Agencies and
trust funds
32%
Foreigners
22%
10