macroeconomic mcgrowhill macro ch 13 19e use this one

Fiscal Policy, Deficits, and Debt 13 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc.. Chapter Objectives• Purposes, Tools, and Limitations of Fiscal Policy • Role

Fiscal Policy, Deficits, and

Debt

13

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

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

Expansionary Fiscal Policy

Real Domestic Output, GDP

$490 $510

Equilibrium Versus Full-Employment GDP

Recessionary Expenditure Gap

Real GDP (billions of dollars)

Recessionary Expenditure Gap = $5 Billion

$5 Billion Gap Yields

$20 Billion GDP Change

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

Contractionary Fiscal Policy

Real Domestic Output, GDP

In Spending

Full $20 Billion Decrease in Aggregate Demand AS

$510 $522

Equilibrium Versus Full-Employment GDP

Inflationary Expenditure Gap

Real GDP (billions of dollars)

Inflationary Expenditure

Gap Yields

$20 Billion GDP Change

–Progressive tax system

–Proportional tax system

–Regressive tax system

Evaluating Fiscal Policy

• Standardized budget

–Full-employment budget

• Cyclical deficit

• Recent U.S fiscal policy

• Budget deficits and projections

• Social security considerations

Evaluating Fiscal Policy

• Is the fiscal policy…

Evaluating Fiscal Policy

G T

GDP 2 GDP 1 Real Domestic Output, GDP

c

Cyclical deficit Fiscal policy neutral

(1) Year

(2) Actual Deficit (-) or Surplus (+)

(3) Standardized Deficit (-) or Surplus (+)

Budget Balances as % of GDP

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

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 +*

•As a percentage of potential GDP

Source: Congressional Budget Office, http://www.cbo.gov.

Fiscal Policy: The Great Recession

• Financial market problems began in

2007

• Credit market freeze

• Pessimism spreads to the overall

economy

• Recession officially began December

2007 and lasted 18 months

Global Perspective

Budget Deficits and Projections

Source: Congressional Budget Office, http://www.cbo.gov.

$200 0 -200 -400 -600 -800 -1000 -1200 -1400 -1600

– Political Business Cycle

– Annual balanced budgets

– Cyclically balanced budgets

• Future policy reversals

• Offsetting state and local finance

• Crowding-out effect

Problems, Criticisms, and ComplicationsFiscal Policy Issues

Current Thinking on Fiscal Policy

• Let the Federal Reserve handle term fluctuations

short-• 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

The U.S Public Debt

The U.S Public Debt

Federal Reserve:

43%

The U.S Public Debt

Global Perspective

Public Sector Debt as Percentage of GDP, 2009

Italy Japan Greece Belgium France United States

France Germany United Kingdom

Spain Netherlands

Canada

0 20 40 60 80 100

Source: Organization for Economic Cooperation and Development, OECD

The U.S Public Debt

• Interest charges on debt

• Largest burden of the debt

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

Crowding Out

0 2 4 6 8 10 12 14 16

Interest Rate Rise Will Decrease Investment

a to b

Out Effect

Crowding-A Large Public Debt to Finance Public Investment Will Cause…

If Public Spending Spurs More Private Investment Will

The Leading Indicators

5 New orders for capital goods

6 Building permits for houses

Social Security, Medicare

Shortfalls

as they age

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

• progressive tax system

• proportional tax system

• regressive tax system

• standardized budget

• cyclical deficit

• political business cycle