Fiscal Policy and Debt PDF

Fiscal Policy and Debt SLIDES CREATED BY ERIC CHIANG CHAPTER Co...

Fiscal Policy and Debt SLIDES CREATED BY ERIC CHIANG CHAPTER Copyright 2023 Macmillan Learning | Chiang | All rights reserved 10 2 | CHAPTER 10 CHAPTER OBJECTIVES Describe the tools that governments use to influence aggregate demand. Explain how expansionary and contractionary fiscal policy works. Determine the influence the multiplier effect has on government spending and aggregate output. Describe the fiscal policies that governments use to influence aggregate supply. 3 | CHAPTER 10 CHAPTER OBJECTIVES Explain the impact of automatic stabilizers and lag effects on fiscal policymaking. Identify the different lags that occur when implementing fiscal policy. Differentiate between deficits and surpluses, and between national debt and public debt. Explain the potential consequences of maintaining high public debt.  FISCAL POLICY IS THE USE OF GOVERNMENT REVENUE (MAINLY TAX RECEIPTS) AND SPENDING TO INFLUENCE THE ECONOMY. FISCAL  EACH YEAR SINCE 2001, THE FEDERAL POLICY GOVERNMENT HAS SPENT FAR MORE THAN IT COLLECTED IN REVENUES, PRODUCING A DEFICIT. THIS DEFICIT ADDS TO THE NATIONAL DEBT. 5 | CHAPTER 10 FEDERAL GOVERNMENT BUDGET (2021) REVENUES ($3.58 TRILLION) EXPENDITURES ($7.25 TRILLION)  DISCRETIONA MANDATORY RY SPENDING SPENDING TWO TYPES OF SPENDING THAT WORKS SPENDING THAT IS FEDERAL THROUGH THE REQUIRED BY LAW. TO SPENDING APPROPRIATI ADJUST ONS SPENDING, PROCESS IN CONGRESS CONGRESS MUST EACH YEAR. CHANGE THE LAW. DISCRETIONA RY SPENDING INCLUDES NATIONAL DEFENSE, TRANSPORTAT ION, SCIENCE, EDUCATION, AND ENVIRONMEN TAL PROTECTION. MANDATORY SPENDING INCLUDES SOCIAL SECURITY, MEDICARE, AND INTEREST ON THE NATIONAL DEBT. 9 | CHAPTER 10 DISCRETIONARY AND MANDATORY SPENDING THE MULTIPLIER LRAS SRAS AND AGGREGATE PRICE LEVEL (P) SPENDING WHEN AN ECONOMY IS BELOW FULL EMPLOYMENT, P1 a FISCAL POLICY SPENDING IS P0 e MAGNIFIED BY THE MULTIPLIER, SHIFTING AD AD1 TOWARD LONG-RUN AD0 EQUILIBRIUM. 0 Q0 Qf AGGREGATE OUTPUT (Q)  SPENDING INJECTIONS INJECTIONS INCLUDE INVESTMENT (I ), GOVERNMENT SPENDING (G ), AND EXPORTS INJECTIONS (X ). SPENDING WITHDRAWALS AND WITHDRAWALS INCLUDE WITHDRAWA SAVINGS (S ), TAXES (T ), AND IMPORTS (M ). LS IN A MACROECONOMIC EQUILIBRIUM: I +G +X =S +T + M   AN INCREASE IN TAXES IS PAID IN PART BY A REDUCTION IN SAVING, ALREADY A WITHDRAWAL FROM THE ECONOMY. TAX  EXAMPLE: A $100 INCREASE IN CHANGES TAXES (WITH MPC = 0.75) RESULTS IN: VS.  $75 REDUCTION IN SPENDING CONSUMPTION. CHANGES  $25 REDUCTION IN SAVINGS.  A $100 REDUCTION IN GOVERNMENT SPENDING WOULD HAVE A LARGER IMPACT ON AGGREGATE OUTPUT.  EXPANSIONAR CONTRACTIO Y FISCAL NARY FISCAL TWO POLICY POLICY TYPES OF INCREASING DECREASING FISCAL GOVERNMENT SPENDING OR GOVERNMENT SPENDING OR POLICY DECREASING TAXES TO INCREASING TAXES TO INCREASE REDUCE AGGREGATE INFLATIONARY DEMAND AND PRESSURES OUTPUT EXPANSIONA RY FISCAL POLICY EXPANSIONARY FISCAL POLICY IS EFFECTIVE WHEN AN ECONOMY IS BELOW LONG-RUN EQUILIBRIUM. BUT ONCE LONG-RUN OUTPUT IS ACHIEVED, EXPANSIONARY FISCAL POLICY LEADS TO DEMAND-PULL INFLATION. CONTRACTIO LRAS SRAS0 NARY FISCAL AGGREGATE PRICE LEVEL (P) POLICY WHEN AN ECONOMY IS ABOVE ITS FULL P0 e EMPLOYMENT OUTPUT LEVEL, a P1 CONTRACTIONARY FISCAL POLICY CAN BE USED TO SHIFT AD BACK TO ITS LONG-RUN AD0 OUTPUT LEVEL, AD1 REDUCING INFLATIONARY 0 Qf Q0 PRESSURES. AGGREGATE OUTPUT (Q)   THE GOAL OF SUPPLY-SIDE FISCAL POLICY IS TO EXPAND THE ECONOMY WITHOUT INCREASING INFLATIONARY PRESSURES. FISCAL  FISCAL POLICY IS DESIGNED POLICY TO SHIFT THE LONG-RUN AGGREGATE SUPPLY CURVE AND TO THE RIGHT. AGGREGAT  THESE POLICIES DO NOT E SUPPLY ALWAYS REQUIRE A TRADEOFF BETWEEN PRICE LEVELS AND OUTPUT.  THEY REQUIRE MORE TIME TO WORK THAN DEMAND- SIDE POLICIES.  EXAMPLES OF SUPPLY-SIDE POLICY: 1. SPENDING ON INFRASTRUCTURE, SUPPLY- EDUCATION, AND TECHNOLOGY SIDE 2. REDUCING TAX RATES FISCAL 3. EXPANDING INVESTMENT AND REDUCING POLICIES REGULATIONS THESE FACTORS HELPED TO KEEP INTEREST RATES AND INFLATION LOW FOR SEVERAL DECADES. FISCAL POLICY AND AGGREGATE SUPPLY IF SUCCESSFUL, FISCAL POLICY DIRECTED AT INCREASING AGGREGATE SUPPLY CAN LEAD TO MORE EMPLOYMENT AND LOWER PRICES.  ARTHUR LAFFER SUGGESTED THAT REDUCING TAX RATES COULD LEAD TO INCREASED TAX REVENUES.  LOWER TAXES ENCOURAGE PEOPLE TO WORK AND ENCOURAGE BUSINESSES THE LAFFER TO INVEST. CURVE  AS INVESTMENT GROWS, INCOMES RISE, WHICH LEADS TO HIGHER TAX REVENUES.  KEY QUESTIONS: WHAT IS THE OPTIMAL TAX RATE? IS MAXIMIZING TAX REVENUES GOOD FOR THE ECONOMY? THE LAFFER CURVE TAX REVENUES RISE AS TAX RATES INCREASE FROM 0% TO POINT b, THEN FALL AS TAX RATES INCREASE FURTHER. DIFFERENT TAX RATES CAN LEAD TO THE SAME AMOUNT OF TAX REVENUE, SUCH AS POINT a AND POINT c.  INVESTMENT CAN BE INCREASED BY:  INVESTMENT TAX CREDITS.  MORE-RAPID ENCOURAGI DEPRECIATION SCHEDULES FOR PLANT NG AND EQUIPMENT.  ALLOWING FIRMS TO INVESTMEN EXPENSE CAPITAL IN A SHORTER PERIOD T REDUCES THE TAX BURDEN.  REPEALING UNNECESSARY REGULATION.  GOVERNMENT GRANTS FOR RESEARCH.  TAX REVENUES AND TRANSFER PAYMENTS AUTOMATICALLY ADJUST TO ECONOMIC FLUCTUATIONS WITHOUT ACTION BY CONGRESS.  WHEN THE ECONOMY IS AUTOMATIC GROWING, TAX REVENUES INCREASE (FROM HIGHER STABILIZERS TAXABLE INCOME) AND TRANSFER PAYMENTS FALL (BECAUSE FEWER PEOPLE REQUIRE INCOME ASSISTANCE).  THESE EFFECTS TEMPER THE INCREASE IN ECONOMIC OUTPUT. FISCAL POLICY TAKES TIME TO WORK. ESPECIALLY IN A DIVIDED GOVERNMENT, THERE IS A TIME LAG FOR A PROBLEM TO BE RECOGNIZED AND SOLUTIONS TO BE IMPLEMENTED.  INFORMATION LAG: MOST DATA THAT POLICYMAKERS NEED ARE NOT AVAILABLE UNTIL AT LEAST ONE QUARTER AFTER THE FACT. FISCAL RECOGNITION LAG: IT TAKES TIME TO RECOGNIZE TRENDS IN THE DATA. POLICY DECISION LAG: POLICIES MUST TIMING BE DEBATED AND PASSED IN CONGRESS AND SIGNED BY THE LAGS PRESIDENT. IMPLEMENTATION LAG: ONCE A POLICY BECOMES LAW, IT TAKES TIME TO PLAN, BUDGET, AND IMPLEMENT THE NEW PROGRAM. FISCAL POLICY IS OFTEN FINANCED BY DEFICITS BECAUSE POLICYMAKER S FIND IT DIFFICULT TO RAISE TAXES OR REDUCE SPENDING.   DEFICIT: AMOUNT BY WHICH ANNUAL GOVERNMENT SPENDING DEFICITS EXCEEDS TAX REVENUES  SURPLUS: AMOUNT BY AND THE WHICH ANNUAL TAX NATIONAL REVENUES EXCEED GOVERNMENT SPENDING DEBT  NATIONAL DEBT: THE TOTAL ACCUMULATION OF PAST DEFICITS LESS SURPLUSES 27 | CHAPTER 10 PUBLIC DEBT AS A PERCENT OF GDP  ANNUALLY BALANCED BUDGET REVENUES AND SPENDING MUST BE EQUAL EACH YEAR. THIS GENERALLY MAKES RECESSIONS APPROACHE WORSE BY FORCING SPENDING CUTS DURING ECONOMIC S TO DOWNTURNS, WHEN TAX REVENUES DROP. BALANCING CYCLICALLY BALANCED BUDGET THE THE BUDGET MUST BE BALANCED OVER THE BUSINESS BUDGET CYCLE BY INCREASES IN TAXES OR REDUCTIONS IN SPENDING DURING PERIODS OF GROWTH TO OFFSET DEFICITS THAT RESULT FROM RECESSIONS.  FUNCTIONAL FINANCE BALANCING THE BUDGET APPROACHE IS NOT THE PRIMARY S TO CONCERN OF POLICYMAKERS. THE BALANCING FOCUS IS ON PROMOTING ECONOMIC GROWTH AND THE STABLE PRICES, AND BUDGET KEEPING THE ECONOMY AS CLOSE AS POSSIBLE TO FULL EMPLOYMENT.  THE GOVERNMENT BUDGET CONSTRAINT: G – T = ΔM + ΔB + ΔA WHERE FINANCING G = GOVERNMENT SPENDING T = TAX REVENUES (G – T IS THE DEBT AND DEFICIT) DEFICITS ΔM = CHANGE IN MONEY SUPPLY (SELLING BONDS TO THE FEDERAL RESERVE) ΔB = CHANGE IN BONDS HELD BY THE PUBLIC ΔA = THE SALE OF GOVERNMENT ASSETS IS THE SIZE OF THE NATIONAL DEBT A PROBLEM? ONLY IF THE COST OF FINANCING THE DEBT PLACES AN EXCESSIVE BURDEN ON 32 | CHAPTER 10 ECONOMIC BURDEN OF THE DEBT LOW U.S. TREASURY RATES OVER THE PAST TWO Interest as a Percent of DECADES ALLOWED INTEREST PAYMENTS ON THE NATIONAL DEBT TO BE GDP LESS THAN 2% OF GDP. HOWEVER, LARGE DEFICITS AND HIGHER INTEREST RATES IN RECENT YEARS WILL INCREASE THE ECONOMIC BURDEN OF THE DEBT. A LARGE PORTION OF THE NATIONAL DEBT IS OWED TO AMERICANS HOLDING TREASURY BONDS. THEREFORE, INTEREST PAYMENTS ON THIS PORTION GO TO OTHER AMERICANS.   A CONCERN REGARDING THE NATIONAL DEBT IS THE EFFECT ON WEALTH DISTRIBUTION. EQUITY  PEOPLE WHO OWN PART ASPECTS OF OF THE NATIONAL DEBT TEND TO BE WEALTHIER THE THAN THOSE WHO DO NOT. NATIONAL  INTEREST PAYMENTS ON DEBT THE DEBT THEREFORE REDISTRIBUTE WEALTH TO THE RICH, LEADING TO GREATER INCOME INEQUALITY. 35 | CHAPTER 10 INTERNAL VERSUS EXTERNAL DEBT TABLE 1 DISTRIBUTION OF U.S. NATIONAL DEBT, AS OF JUNE 2022 (TRILLIONS) Amou Perce nt nt Held by the Federal Reserve and $6.513 21.5% government agencies Held by the public 23.765 78.5 Held by foreigners 7.967 26.3 Held domestically 15.798 52.2 Total ABOUT national debt OF ALL DEBT HELD BY30.278 ONE-THIRD 100.0 IS THE PUBLIC 0 HELD BY FOREIGNERS (EXTERNAL DEBT). INTEREST PAYMENTS TO FOREIGNERS ARE A REAL CLAIM ON U.S. OUTPUT.   ANOTHER CONCERN IS THAT GOVERNMENT FINANCES ITS DEBT BY SELLING BONDS, PUSHING THE INTEREST RATE HIGHER.  HIGHER INTEREST RATES CROWDING- MAKE CONSUMERS AND BUSINESSES LESS LIKELY OUT EFFECT TO BORROW FOR PURCHASES AND INVESTMENT.  THEREFORE, GOVERNMENT DEBT CROWDS OUT CONSUMPTION AND INVESTMENT, LEADING TO A LESS PRODUCTIVE FUTURE ECONOMY. FISCAL SUSTAINABILIT Y OCCURS WHEN THE PRESENT VALUE OF ALL PROJECTED FUTURE REVENUES EQUALS THE PRESENT VALUE OF PROJECTED FUTURE  SADIE ALEXANDER (1898– 1989) She was the first African American to earn an Ph.D. in economics, which she accomplished in 1921 at the University of Pennsylvania. Pursued a career in civil rights law, while continuing to write economic papers focusing on fiscal policy and economic 39 | CHAPTER 10 KEY CONCEPTS discretionary spending automatic stabilizers annually balanced mandatory spending information lag budget discretionary fiscal recognition lag cyclically balanced policy budget decision lag expansionary fiscal functional finance implementation lag policy government budget public choice theory constraint contractionary fiscal policy deficit internally held debt supply-side fiscal surplus externally held debt policies national debt crowding-out effect Laffer curve public debt 40 | CHAPTER 10 QUESTION: A. SPENDING ON EDUCATION WHICH OF THE FOLLOWING IS B. SOCIAL SECURITY BENEFITS MANDATORY SPENDING, C. MAINTAINING ROADS AND WHICH CANNOT BRIDGES BE ADJUSTED WITHOUT D. NATIONAL DEFENSE CHANGING THE LAW? E. ENVIRONMENTAL PROTECTION PRACTICE QUESTION : IF THE ECONOMY IS IN A RECESSION, WHAT TYPES OF FISCAL POLICIES CAN SPEED UP THE RECOVERY? 42 | CHAPTER 10 A. INCREASING GOVERNMENT QUESTION: SPENDING WHICH OF THE FOLLOWING IS B. EXPANDING TRANSFER PAYMENTS AN EXAMPLE OF C. SUBSIDIZING BASIC RESEARCH CONTRACTIONA RY FISCAL D. EXPANDING FEDERAL HEALTH CARE COVERAGE POLICY? E. INCREASING INCOME TAX RATES PRACTICE QUESTION : IF THE GOVERNMENT DEFICIT IS REDUCED BY HALF OVER THE NEXT FIVE YEARS, WILL THE PUBLIC DEBT CONTINUE TO RISE? 44 | CHAPTER 10 QUESTION: A. SELLING ASSETS OWNED BY THE GOVERNMENT WHICH OF THE FOLLOWING IS B. SELLING BONDS TO FOREIGN NOT A WAY GOVERNMENTS THE C. INCREASING THE MONEY SUPPLY BY GOVERNMENT PRINTING MONEY CAN FINANCE D. SELLING BONDS TO DOMESTIC CITIZENS ITS DEFICIT? E. BUYING BONDS FROM THE FEDERAL RESERVE  End of Chapter SLIDES CREATED BY ERIC CHIANG Copyright 2023 Macmillan Learning | Chiang | All rights reserved