micro economics chapter 13 1

13
Fiscal Policy, Deficits, and
Debt

McGraw-Hill/Irwin

Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.


Fiscal Policy

• Council of Economic Advisors (CEA)
• Deliberate changes in
• Government spending
• Taxes
• Designed to
• Achieve full-employment
• Control inflation
• Encourage economic growth
LO1


Fiscal Policy

• Define:
• Budget deficit
• Budget surplus
• National, or public, debt

LO1

Expansionary Fiscal Policy

• Increases AE, GDP, and employment
• Increase government spending
• Decrease taxes
• Combination of both
• Expansionary policy creates a deficit
(G > Tax revenue)

LO1


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

LO1


Contractionary Fiscal Policy

• Decreases AE, GDP, and

•

LO1

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

LO1


Policy Options: G or T?

• Expand the size of government
• Increase government spending
• Increase taxes

• Reduce the size of government
• Decrease taxes
• Decrease government spending
LO1


Built-In Stability

• Automatic stabilizers
• Tax revenues vary directly with

•
LO2

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

LO3


Recent U.S. Fiscal Policy

LO3


Fiscal Policy: The Great Recession

• Financial market problems began in
•

LO4

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
LO4


Budget Deficits and Projections

LO4


Problems, Criticisms, &
Complications

• Problems of Timing
• Recognition lag
• Administrative lag
• Operational lag
• Political considerations
– political business cycle
• Future policy reversals
• Off-setting state and local finance
• Crowding-out effect
LO4


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.

LO4


The U.S. Public Debt

• $18.2 trillion in 2017
• The accumulation of years of
•
•
•
LO4

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
•

LO4

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

LO4


The U.S. Public Debt

• False Concerns

• Bankruptcy
• Refinancing
• Taxation
• Burdening future generations

LO4


The U.S. Public Debt

LO4


The U.S. Public Debt

• 33% of debt is externally held debt –
•
•

LO4

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

LO4


Substantive Issues

• Income distribution
• Incentives
• Foreign-owned public debt
• Crowding-out effect revisited
• Future generations
• Public investment
LO4