micro economics chapter 13 1

Fiscal Policy, Deficits, and Debt13... GDP • Spending is too low at full-employment • Use expansionary fiscal policy to increase AE • Desirable to create a deficit... GDP • Spending is t

Fiscal Policy, Deficits, and

Debt13

Expansionary Fiscal Policy

• Increases AE, GDP, and employment

• Increase government spending

• Decrease taxes

• Combination of both

• Expansionary policy creates a deficit (G > Tax revenue)

Equilibrium vs Full Employment

• Recessionary Expenditures Gap

• Amount that AE must increase to reach full-employment, eq GDP

• Spending is too low at full-employment

• Use expansionary fiscal policy to increase AE

• Desirable to create a deficit

Contractionary Fiscal Policy

• Decreases AE, GDP, and

employment

• Decrease government spending

• Increase taxes

• Combination of both

• Contractionary policy creates a

budget surplus (G < Tax revenue)

Equilibrium vs Full Employment

• Inflationary Expenditures Gap

• Amount that AE must decrease to reach full-employment, eq GDP

• Spending is too high at full-employment

• Use contractionary fiscal policy to decrease AE

• Desirable to create a surplus

Policy Options: G or T?

• Expand the size of government

• Increase government spending

Built-In Stability

• Automatic stabilizers

• Tax revenues vary directly with GDP

• Transfers vary inversely with GDP

• Automatically creating a surplus

during inflation and a deficit during recession

• Reduces severity of business

fluctuations

Evaluating Fiscal Policy

• Use the cyclically adjusted budget to

evaluate fiscal policy

• Removes impact of built-in stabilizers

• Size of deficit/surplus if the economy is at full-employment for the year

• Cyclically adjusted budget only changes when government changes fiscal policy

Recent U.S Fiscal Policy

Fiscal Policy: The Great Recession

• Financial market problems began in

2007

• In 08 passed $152 billion stimulus

consisting of tax breaks

• Most people saved or paid credit cards

• Not very expansionary

Fiscal Policy: The Great Recession

• In 09 passed American Recovery &

Reinvestment Act with $787 billion

stimulus

• Decreased taxes for low/middle income

• No lump sum checks

• Increased spending on transportation,

ed, and aid to state governments

Budget Deficits and Projections

Problems, Criticisms, &

– political business cycle

• Future policy reversals

• Off-setting state and local finance

• Crowding-out effect

Problems, Criticisms, &

Complications

• Biggest criticism of fiscal policy is

Crowding-Out Effect

• Crowding-Out Effect – When

government borrows money, demand for money increases, and interest rates rise, reducing (crowding-out) investment

– Offsets expansionary impacts of fiscal

policy.

The U.S Public Debt

• $18.2 trillion in 2017

• The accumulation of years of federal deficits and surpluses

• Owed to the holders of U.S securities

• Caused by war, recession, and fiscal policy

• Video Debt

The U.S Public Debt

• GDP is income of a nation

• Larger income means a greater ability

to carry a large debt

• Look at debt as percentage of GDP

as better gauge

The U.S Public Debt

• Interest charges on debt

• Largest burden of the debt

• Must at least pay interest every year

• 2.2% of GDP in 2015

• When interest as a percent of GDP increases, must raise taxes

The U.S Public Debt

The U.S Public Debt

The U.S Public Debt

• 33% of debt is externally held debt – paying it back will decrease RGDP

• 67% of debt is internally held debt – paying it back will not reduce RGDP

• Debt is an asset as owners of debt and a liability as taxpayers

The U.S Public Debt

Substantive Issues

• Income distribution

• Incentives

• Foreign-owned public debt

• Crowding-out effect revisited

• Future generations

• Public investment