Fiscal Policy, Deficits, and Debts PDF

33 Fiscal Policy, Deficits, and Debt McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.  Fiscal Policy Deliberate changes in: Government spending...

33 Fiscal Policy, Deficits, and Debt McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.  Fiscal Policy Deliberate changes in: Government spending Taxes Designed to: Achieve full-employment Control inflation Encourage economic growth LO1  Expansionary Fiscal Policy Use during a recession Increase government spending Decrease taxes Combination of both Create a deficit LO1  Expansionary Fiscal Policy $5 billion Recessions increase in Decrease AD spending AS Full $20 billion Price level increase in aggregate demand P1 AD1 AD2 $490 $510 Real GDP (billions) LO1  Contractionary Fiscal Policy Use during demand-pull inflation Decrease government spending Increase taxes Combination of both Create a surplus LO1  Contractionary Fiscal Policy $3 billion initial decrease in spending AS Price level P2 d c b Full $12 billion decrease in aggregate demand P1 a AD4 AD AD3 5 $502 $510 $522 Real GDP (billions) LO1  Policy Options: G or T? To expand the size of government (unmet social needs or infrastructure) If recession, then increase government spending If inflation, then increase taxes To reduce the size of government (govt. is too large and inefficient) If recession, then decrease taxes If inflation, then decrease government spending LO1  Built-In Stability Automatic stabilizers Taxes vary directly with GDP Transfers vary inversely with GDP Reduces severity of business fluctuations Tax progressivity Progressive tax system Proportional tax system Regressive tax system LO2  Built-In Stability T Government expenditures, G, and tax revenues, T Surplus G Deficit GDP1 GDP2 GDP3 Real domestic output, GDP LO2  Evaluating Fiscal Policy Is the fiscal policy… Expansionary? Neutral? Contractionary? Use the cyclically adjusted budget to evaluate LO3  Cyclically Adjusted Budgets T Government expenditures, G, and tax revenues, T (billions) b a $500 G 450 c GDP2 GDP1 (year 2) (year 1) Real domestic output, GDP LO3  Cyclically Adjusted Budgets T1 Government expenditures, G, and T2 tax revenues, T (billions) e d $500 G 475 h 450 f 425 g GDP4 GDP3 (year 4) (year 3) Real domestic output, GDP LO3  Recent U.S. Fiscal Policy Federal Deficits (-) and Surpluses (+) as Percentages of GDP, 2000-2009 (3) (2) Cyclically Actual Adjusted (1) Deficit – or Deficit – or Year Surplus + 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, www.cbo.gov. LO3 Fiscal Policy: The Great Recession Financial market problems began in 2007 Credit market freeze Pessimism spreads to the overall economy Recession officially began December 2007 and lasted 18 months LO4  Budget Deficits and Projections Actual Projected (as of March 2010) $200 Budget Deficit (-) or Surplus, Billions 0 -200 -400 -600 -800 -1000 -1200 -1400 -1600 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 Source: Congressional Budget Office, www.cbo.gov. LO4  Global Perspective LO4  Problems, Criticisms, & Complications Problems of Timing Recognition lag Administrative lag Operational lag Political business cycles Future policy reversals Off-setting state and local finance Crowding-out effect LO4  Current Thinking on Fiscal Policy Let the central bank through its monetary policy handles short-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 LO4  The U.S. Public Debt $11.9 trillion in 2009 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 LO4  The U.S. Public Debt Debt held Debt held by outside the Federal the Federal government government and the and the Federal Federal Reserve: Reserve: 43% 57% LO4  The U.S. Public Debt LO4  Global Perspective Public Sector Debt as Percentage of GDP, 2009 0 20 40 60 80 100 Italy Japan Greece Belgium Hungary United States France Germany United Kingdom Spain Netherlands Canada Source: Organization for Economic Cooperation and Development, OECD LO4  The U.S. Public Debt Interest charges on debt Largest burden of the debt 1.3% of GDP in 2009 False Concerns (but recent events show that these are valid concerns) Bankruptcy? Ability to Refinance debts Ability to Tax Burdening future generations? Financial assets are inherited by future generations LO4  Substantive Issues Income distribution- benefit holders of bonds Lower Incentives with higher tax Foreign-owned public debt Crowding-out effect revisited Public investment to off-set crowding- out future generations LO4  Crowding-Out Effect 16 14 Real interest rate (percent) Increase in 12 investment b c demand 10 8 a 6 Crowding-out 4 effect ID2 2 ID1 0 5 10 15 20 25 30 35 40 Investment (billions of dollars) LO4 Increasing Cost to Govt on Social Policies – Aging population- grater demand for social protection – Cost ofmedical care –Cost of social care –Insufficient retirement plan Increasing Cost to Govt on Social Policies Possible options “to fix” include: Increasing the retirement age Increasing the portion of earnings subject to the social security and retirement contribution Disqualifying wealthy individuals higher-skilled, higher paying work Supplement with voluntary retirement contribution