ECON 0110 Lecture Notes - Lecture 7: Balanced Budget Amendment, Government Budget Balance, Government Debt
Government Spending
Social Insurance
Government programs intended to protect families against economic hardship
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In the US, social insurance programs are paid for with the social insurance taxes.
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Fiscal Policy
GDP = C + I + G + X - IM
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The government directly controls G & it indirectly controls C & I.
Households' disposable incomes are affected by taxes and transfers, and
disposable income affects consumption.
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Business investment is also affected by taxes.
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Stabilization Policy
The use of government policy to reduce the severity of recessions and rein in
excessively strong expansions.
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Fiscal Policy
The use of government spending or tax policy to stabilize the economy
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Shifts the aggregate demand curve
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The government plays a large role in the economy so changes in government
spending or taxation can have a large effect on the economy.
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Expansionary Fiscal Policy
Fiscal policy that increases aggregate demand
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Examples:
An increase in government spending
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A tax cut
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An increase in government transfers
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Rather than waiting for nominal wages to fall and self-correction to occur, the
government can try to increase aggregate demand to return to long run
macroeconomic equilibrium
Like when a positive demand shock happens
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Contractionary Fiscal Policy
Fiscal policy that reduces aggregate demand
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Examples
A decrease in government spending
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A tax increase
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A reduction in government transfers
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Rather than waiting for nominal wages to rise and self-correcting to occur, the
government can try to decrease aggregate demand to return to long run
macroeconomic equilibrium
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Practice Problem
In each of the following cases, determine whether the policy is an expansionary or
contractionary fiscal policy.
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Several military bases around the country, which together employ tens of
thousands of people, are closed.
a.
The number of weeks an unemployed person is eligible for unemployment benefits is
increased.
b.
The federal tax on gasoline is increased.
c.
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Fiscal Policy
The use of fiscal policy is often controversial.
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Can expansionary fiscal policy actually work?
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Three commonly given arguments against using expansionary fiscal policy:
Government spending always crowds out private spending.
"Every dollar the government spends is a dollar taken away from the
private sector (taxes)."
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Assumes resources in the economy are fully employed. This is true if the
economy is producing at its potential output.
It is in long-run macroeconomic equilibrium.
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This is not true if the economy is producing below its potential output (in
recession) because some resources are not being employed.
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Government spending puts unemployed resources to work and generates
higher spending and higher income.
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Government borrowing always crowds out private investment.
"Government borrowing uses funds that would have otherwise been used
for private investment spending."
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Again, true if the economy is not depressed.
Not true if the economy is depressed.
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Fiscal policy will lead to higher incomes, which in turn leads to increased
savings at any given interest rates.
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The larger pool of savings allows the government to borrow without
driving up interests.
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Government budget deficits lead to reduced private spending.
"Expansionary fiscal policy leads to a larger budget deficit and greater
government debt. Higher debt will eventually require the government to
raise taxes to pau it off."
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Ricardian Equivalence
Consumers will anticipate that a tax cut today (or an increase in the
government budget deficit) will lead to a tax increase in the future
and they will, therefore, cut their spending today.
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This is a valid concern, but in reality consumers do not behave with such
foresight.
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Lags in Fiscal Policy
Many economists caution against an extremely active stabilization policy.
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A government that tries too hard to stabilize the economy can end up making the
economy less table.
There are important time lags between when the policy is decided upon and
when it is implemented.
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Government has to realize the gap exists, develop a spending plan, and spend
money.
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By that time, the economy might have already recovered on its own.
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Practice Problem
Which of the following statements is true? Holding everything constant:
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An economy can eliminate an inflationary gap by increasing government spending.
a.
Expansionary fiscal policy refers to an increase in taxes.
b.
When potential output is greater than actual aggregate output, the economy faces a
recessionary gap.
c.
When SRAS intersects AD to the right of the long-run aggregate supply (LRAS)
curve, the economy faces a recessionary gap.
d.
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Fiscal Policy and the Multiplier
Expansionary fiscal policies shift AD to the RIGHT.
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Contractionary fiscal policies shift AD to the LEFT.
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Policy makers also have to know how much they want the aggregate demand curve
to shift.
To determine this, they estimate the output gap and the multiplier.
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Increase in government spending DIRECTLY increases AD.
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Tax cuts and increased transfers INDIRECTLY effect aggregate demand only
through increase in consumer spending.
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In general, a change in government taxes or transfers shifts AD LESS than a change
in government spending.
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EXAMPLE 1:
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EXAMPLE 2:
Suppose the recessionary gap = $1,000 billion and MPC = 0.5. How much
should the government increase spending by (not through tax cuts &
transfers)?
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Fiscal Policy & the Budget Balance
Fiscal policy changes the government's budget balance: the difference between tax
revenue and government spending.
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Budget Balance (Sgovernment) = T - G - TR
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Budget Surplus
Positive budget balance in a year
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Budget Deficit
Negative budget balance in a year
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The budget balance can be used to measure whether the government is engaging in
expansionary or contractionary fiscal policy.
Other things equal, an expansionary fiscal policy decreases the budget balance.
Reduces the surplus or makes the deficit larger.
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Other things equal, a contractionary fiscal policy increases the budget balance.
Increases the surplus or makes the deficit smaller.
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Much of the relationship between the budget balance and recessions are due to
automatic stabilizers, not policy makers "getting it right".
Automatic Stabilizers
Government spending and taxation rules that cause fiscal policy to be
automatically expansionary when the economic contracts and
automatically contractionary when the economy expands.
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Discretionary Fiscal Policy
Fiscal policy that is the result of deliberate actions by policy makers
rather than rules.
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Cyclically Adjusting Budget Balance
An estimate of what the budget deficit would be if the economy was at potential
output.
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Should the budget be balanced annually?
Most economists think the budget should be balanced "on average", but not
every year.
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Governments should be allowed to run deficits in recession years to help
stimulate the economy.
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Automatic stabilizers force the government toward a budget deficit.
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A balanced budget amendment would force the government to adopt a
contractionary fiscal policy during a recession, which would make the
recession worse.
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Long-Run Implications of Fiscal Policy
Persistent budget deficits lead to an increase in government debt and public debt.
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A government budget deficit (or surplus) is the budget balance for one particular
year.
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Government Debt
The sum of all the past budget deficits and surpluses.
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Public Debt
Government debt held by individuals and instructions outside of the
government
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Debt - GDP Ratio
The government debt as a percentage of GDP
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Year
Real GDP
($ billions)
Debt
($ billions)
Budget
Deficit
($ billions)
Debt - GDP
Ratio
Budget
Deficit
(% of GDP)
2012
$1,000
$300
$30
2013
$1,030
$30
2014
$1,061
$30
2015
$1,093
$30
2016
$1,126
$30
2017
$1,159
$30
2018
$1,194
$30
Like individuals, governments must pay their bills, including any interest on their
debt.
In 2013, the US governments interest payments were $221 billion, 1.3% of the
GDP.
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A government that borrows to pay its interest pushes itself deeper into debt.
Eventually lenders may questions governments ability to repay its debt.
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This increases the interest rate on the debt even further, making default even
more likely.
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This can result in the government defaulting.
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Stopping payment on its debts.
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Defaulting can wreak havoc on a country's economy.
Its like government bankruptcy.
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Can result in a country having severe recession.
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Can sometimes lead to the overthrow of a government.
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Austerity
Sharp cuts in spending plus tax increase
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In Europe, many heavily indebted countries were forced to adopt austerity
measures to be eligible to receive aid.
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Implicit Liabilities
Spending promises made by governments that are effectively a debt despite
the fact that they are not included in the usual debt statistics
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The 3 largest US implicit liabilities:
Medicare
Healthcare spending is increasing much faster than overall spending
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Medicaid
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Social Security
Pay-as-you-go system where current workers pay for current
retirees.
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2010: 32 retirees for every 100 workers
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2030: 46 retirees for every 100 workers
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2050: 48 retirees for every 100 workers
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Lecture 7
Sunday,*June*17,*2018
1:16*PM
Document Summary
Government programs intended to protect families against economic hardship. In the us, social insurance programs are paid for with the social insurance taxes. Gdp = c + i + g + x - im. The government directly controls g & it indirectly controls c & i. Households" disposable incomes are affected by taxes and transfers, and disposable income affects consumption. The use of government policy to reduce the severity of recessions and rein in excessively strong expansions. The use of government spending or tax policy to stabilize the economy. The government plays a large role in the economy so changes in government spending or taxation can have a large effect on the economy. Rather than waiting for nominal wages to fall and self-correction to occur, the government can try to increase aggregate demand to return to long run macroeconomic equilibrium.
