macroeconomic mcgrowhill macro ch 13 19e use this one

13
Fiscal Policy, Deficits, and
Debt

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

30-2


Fiscal Policy
• Council of Economic Advisers
(CEA)
• Discretionary fiscal policy
– Eliminate recessionary or
inflationary gap
– Countercyclical

• Nondiscretionary fiscal policy
– Passive or automatic
30-3


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
30-4


Expansionary Fiscal Policy
Recessions
Decrease
Aggregate
Demand

Price Level

$5 Billion
Additional
Spending

AS

Full $20 Billion
Increase in
Aggregate Demand

P1

AD1
AD2
$490

$510

Real Domestic Output, GDP
30-5


Equilibrium Versus
Full-Employment GDP
Recessionary Expenditure Gap
Aggregate Expenditures
(billions of dollars)

550

530

510

AE0
AE1

$5 Billion
Gap Yields
$20 Billion
GDP
Change

Recessionary
Expenditure
Gap = $5 Billion

490

470

Full
Employment
45°
490

510

530

Real GDP (billions of dollars)
30-6

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

30-7


Contractionary Fiscal Policy
Reduce
Demand Pull
Inflation

$5 Billion
Initial Decrease
In Spending

Price Level

AS

Full $20 Billion
Decrease in

Aggregate Demand

P1

AD4
AD3
$510

$522

Real Domestic Output, GDP
30-8


Equilibrium Versus
Full-Employment GDP
Inflationary Expenditure Gap
AE2

Aggregate Expenditures
(billions of dollars)

550

530

AE0

Inflationary
Expenditure

Gap = $5 Billion

$5 Billion
Gap Yields
$20 Billion
GDP
Change

510

490

470

Full
Employment
45°
490

510

530

Real GDP (billions of dollars)
30-9


Built-In Stability
• Automatic stabilizers
– Taxes and transfers

• Economic importance
• Tax progressivity
– Progressive tax system
– Proportional tax system
– Regressive tax system
30-10


Built-In Stability

Government Expenses, G
and Tax Revenues, T

T

Surplus
G

Deficit

GDP1
GDP2
GDP3
Real Domestic Output, GDP
30-11


Evaluating Fiscal Policy
• Standardized budget

– Full-employment budget

•
•
•
•

Cyclical deficit
Recent U.S. fiscal policy
Budget deficits and projections
Social security considerations
30-12


Evaluating Fiscal Policy

• Is the fiscal policy…
• Expansionary?
• Neutral?
• Contractionary?
• Use the cyclically adjusted budget to
evaluate

LO3

13-13


Government Expenses, G
and Tax Revenues, T

Evaluating Fiscal Policy
T

Cyclical deficit
Fiscal policy
neutral

$500

$450

a

b

G

c

GDP2

(Year 2)

GDP1

(Year 1)

Real Domestic Output, GDP
30-14

Government Expenses, G
and Tax Revenues, T

Evaluating Fiscal Policy
Standardized deficit
Expansionary fiscal
policy

$500

d

e

$475
$450
$425

T1
T2

G
h

f
g

GDP4

(Year 4)

GDP3

(Year 3)

Real Domestic Output, GDP
30-15


Budget Balances as % of GDP
(1)
Year

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

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

1992
1993
1994
1995
1996

1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007

-4.5%
-3.8%
-2.9%
-2.2%
-1.4%
-0.3%
+0.8%
+1.4%
+2.5%
+1.3%
-1.5%
-3.4%
-3.5%
-2.6%
-1.9%
-1.3%

-2.9%

-2.9%
-2.1%
-2.0%
-1.2%
-1.0%
-0.4%
+0.1%
+1.1%
+1.0%
-1.2%
-2.5%
-2.4%
-1.9%
-1.8%
-1.4%
Source: Congressional Budget Office

30-16


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 +*

2000

+2.4

+1.1

2001

+1.3

+0.5

2002

-1.5

-1.3

2003

-3.4

-2.7

2004

-3.5

-3.2

2005

-2.6

-2.5

2006

-1.9

-2.0

2007

-1.2

-1.2

2008

-3.2

-2.8

2009

-9.9

-7.3

•As a percentage of potential GDP
Source: Congressional Budget Office, .
LO3

13-17


Fiscal Policy: The Great Recession

• Financial market problems began in
•
•
•

LO4

2007
Credit market freeze
Pessimism spreads to the overall
economy
Recession officially began December
2007 and lasted 18 months

13-18


Global Perspective

LO4

13-19


Budget Deficits and Projections
Actual
Projected
(as of March 2010)

Budget Deficit (-) or Surplus, Billions

$200
0
-200
-400
-600
-800
-1000
-1200
-1400
-1600
1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014
Source: Congressional Budget Office, .
LO4

13-20


Fiscal
Policy
Issues
Problems, Criticisms, and Complications
• Problems of timing
– Recognition lag
– Administrative lag
– Operational lag
• Political considerations
– Political Business Cycle
– Annual balanced budgets
– Cyclically balanced budgets

• Future policy reversals
• Offsetting state and local finance
• Crowding-out effect
30-21


Current Thinking on Fiscal Policy

• Let the Federal Reserve handle short•
•
•
LO4

term fluctuations
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
13-22


The U.S. Public Debt

•

•

LO4

$11.9 trillion in 2009 ($9.01 Trillion 2007
and $7.96 Trillion in 2005)
• The accumulation of years of federal
deficits and surpluses
Owed to the holders of U.S. securities
• Treasury bills
• Treasury notes
• Treasury bonds
• U.S. savings bonds
13-23

The U.S. Public Debt
Debt held
outside
the Federal
government
and the
Federal
Reserve:
57%

LO4

Debt held by
the Federal
government
and the
Federal
Reserve:
43%

13-24


The U.S. Public Debt

LO4

13-25