Fiscal Policy Quiz

Fiscal Policy, Deficits, and Debt

• Fiscal policy involves deliberate changes in government spending and taxes.
• Goals of fiscal policy include achieving full employment, controlling inflation, and encouraging economic growth.
• Expansionary fiscal policy is used during recessions. It involves increasing government spending and/or decreasing taxes to boost aggregate demand.
• Contractionary fiscal policy is used during periods of demand-pull inflation. It involves decreasing government spending and/or increasing taxes to decrease aggregate demand.

Expansionary Fiscal Policy

• Used during recessions.
• Increases government spending.
• Decreases taxes.
• Creates a budget deficit.

Contractionary Fiscal Policy

• Used during periods of inflation.
• Decreases government spending.
• Increases taxes.
• Creates a budget surplus.

Policy Options: G or T?

• To increase government, use increased government spending if recessionary, and increased taxes during inflation.
• To decrease government, use decreased government spending during inflation, and decreased taxes during a recession.

Built-In Stability

• Automatic stabilizers help moderate economic fluctuations.
• Taxes rise and transfers decline when the economy expands, reducing aggregate demand.
• Taxes fall and transfers rise when the economy contracts, increasing aggregate demand.
• Tax progressivity (higher earners pay progressively higher percentage of income in taxes) and proportional tax systems are automatic stabilizers.

Evaluating Fiscal Policy

• Fiscal policy is evaluated using the cyclically adjusted budget.
• This involves adjusting the actual budget to account for the impact of business cycles.

Recent U.S. Fiscal Policy (2000-2009)

• Data is provided as a percentage of GDP.
• Shows both actual and cyclically adjusted deficits and surpluses over the years.

Fiscal Policy: The Great Recession

• Financial market problems began in 2007.
• A credit market freeze and broader economic pessimism followed.
• The recession officially began in December 2007 and lasted 18 months.

Budget Deficits and Projections

• Data is presented graphically to show actual deficits and projected deficits from 1994 to 2014.

Global Perspective

• Data on cyclically adjusted budget surpluses or deficits (as a percentage of potential GDP) for various countries in 2009 is shown.

Problems, Criticisms, & Complications

• Problems of timing (recognition, administrative, operational lags).
• Political business cycles.
• Policy reversals.
• Off-setting state and local finance.
• Crowding-out effect.

Current Thinking on Fiscal Policy

• Central banks should handle short-term economic fluctuations.
• Fiscal policy should be evaluated based on long-term results rather than short-term impacts.
• Tax cuts can encourage work effort, investment, and innovation.
• Government spending should be focused on public capital projects.

The U.S. Public Debt

• The U.S. public debt was $11.9 trillion in 2009.
• The debt is owed to holders of U.S. securities (Treasury bills, notes, bonds, savings bonds).
• Breakdown of who holds the debt (Federal Reserve, U.S. banks and other financial institutions, foreign ownership, U.S. individuals, U.S. government agencies).
• The debt has been growing as a percentage of GDP over multiple decades (shown in a graph).

The U.S. Public Debt (Concerns)

• Interest charges on debt are a substantial burden.
• 1.3% of GDP in 2009 isn't a trivial amount.
• Recent events illustrate these concerns are still a current problem.
• Questions about bankruptcy, ability to refinance debt, ability to tax, burdening future generations, and who benefits.

Substantive Issues

• Income distribution due to bond ownership.
• Lower incentives with increased taxes.
• Foreign-owned public debt.
• Crowding-out effect, and potential solutions.
• Future generations' impact.

Crowding-Out Effect

• A reduction in investment spending caused by government borrowing.
• Government borrowing raises interest rates making it less attractive for business investment.
• Graph shows how potential investment is decreased due to governmental borrowing.

Increasing Cost to Govt on Social Policies

• Aging population places greater demand on social protection.
• Costs of medical and social care.
• Insufficient retirement plans.

Increasing Cost to Govt on Social Policies (Possible Solutions)

• Increasing retirement age.
• Increasing portion of earnings subject to social security and retirement contributions.
• Disqualifying wealthy individuals (who may be contributing to wealth-gap issues).
• Higher-skilled, higher-paying work opportunities.
• Supplement with voluntary retirement contributions.