Transcript PPT

Macroeconomic
Policy Debates
PREPARED BY:
FERNANDO QUIJANO, YVONN QUIJANO,
KYLE THIEL & APARNA SUBRAMANIAN
© 2007 Pearson/Prentice Hall Economics: Principles, Applications, and Tools, 5e O’Sullivan • Sheffrin • Perez
chapter
1 What are the long-term fiscal imbalances for the United States?
New Methods to Measure the Long-Term Fiscal Imbalances for the United States
2 What does the current chairman of the Federal Reserve think about inflation
targeting?
Bernanke on Inflation Targeting
3 What type of tax is the “flat tax”?
The Flat Tax Is a Tax on Consumption
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17.1
SHOULD WE BALANCE THE FEDERAL BUDGET?
• government expenditures
Spending on goods and services
plus transfer payments.
• surplus
The amount by which government
revenues exceed government
expenditures in a given year.
• deficit
The amount by which government
expenditures exceed government
revenues in a given year.
• government debt
The total of all past government
deficits.
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17.1
SHOULD WE BALANCE THE FEDERAL BUDGET?
The Budget in Recent Decades
► FIGURE 17.1
Debt as a Percent of GDP,
1791–2005
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17.1
SHOULD WE BALANCE THE FEDERAL BUDGET?
The Budget and Social Security
Five Debates About Deficits
DEBATE 1: DO DEFICITS LEAD TO INFLATION?
government deficit = new borrowing from the public + new money created
• monetizing the deficit
Purchases by a central bank of
newly issued government bonds.
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17.1
SHOULD WE BALANCE THE FEDERAL BUDGET?
Five Debates About Deficits
DEBATE 2: IS GOVERNMENT DEBT A BURDEN ON
FUTURE GENERATIONS?
• Ricardian equivalence
The proposition that it does
not matter whether government
expenditure is financed by taxes
or debt.
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17.1
SHOULD WE BALANCE THE FEDERAL BUDGET?
Five Debates About Deficits
DEBATE 2: IS GOVERNMENT DEBT A BURDEN ON
FUTURE GENERATIONS?
► FIGURE 17.2
International Comparisons
of Government Debt as
Percentage of GDP, 2005
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17.1
SHOULD WE BALANCE THE FEDERAL BUDGET?
Five Debates About Deficits
DEBATE 3: HOW DO DEFICITS AFFECT THE SIZE
OF GOVERNMENT?
DEBATE 4: CAN DEFICITS BE GOOD FOR AN ECONOMY?
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NEW METHODS TO MEASURE THE LONG-TERM FISCAL IMBALANCES FOR THE UNITED STATES
APPLYING THE CONCEPTS #1: What are the long-term fiscal imbalances for the United States?
Even though federal budget-deficit projections have increased in recent years, they still don’t
accurately portray the long-run fiscal problems facing the United States.
Over time, there will be an escalating gap between revenues and expenditures, which would
have to be met by outright borrowing.
How can we measure the size of the gap?
• Economists have developed a more comprehensive measure of a nation’s
indebtedness. The method includes estimating the present value of the gap between
the government’s revenues and expenditures and adding it to the current national debt.
• The “fiscal imbalance” was calculated in 2003 to be approximately $44 trillion, or
four times GDP.
• During World War II, government debt was only 1.2 times GDP.
Problem:
No one will lend the U.S. government that amount of money.
Economists estimate that about 80 percent of the fiscal imbalance will stem from Medicare.
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17.1
SHOULD WE BALANCE THE FEDERAL BUDGET?
Five Debates About Deficits
DEBATE 5: WOULD A BALANCED-BUDGET
AMENDMENT REALLY WORK?
Critics of a balanced-budget amendment point to many different problems,
such as the following:
• A balanced budget may not allow enough flexibility, or room, for the
government to effectively deal with recessions.
• The Constitution is not the right mechanism to try to enforce complicated
budget rules.
• Congress could devise special budgets to get around the requirement,
for example, by taking some types of spending “off budget,” which
means simply not counting them as part of the official budget.
• Congress could also find non-budgetary ways to carry out the policies
that it desires.
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17.2
SHOULD THE FED TARGET INFLATION?
Two Debates About Inflation Targeting
DEBATE 1: SHOULD THE FED FOCUS ON ONLY INFLATION?
DEBATE 2: IF THERE WERE AN INFLATION TARGET, WHO
WOULD SET IT?
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BERNANKE ON INFLATION TARGETING
APPLYING THE CONCEPTS #2: What does the current chairman
of the Federal Reserve think about inflation targeting?
Before he took over as chairman of the Federal Reserve in
2006, Ben Bernanke was an advocate for inflation targeting.
• Inflation targeting increased the effectiveness of monetary policy because it provided a
long-term anchor for inflation expectations.
• As long as the private sector understood that the Fed was holding firm to long-run
inflation targets, it would have added flexibility to use aggressive monetary policy in the
short run to offset adverse shocks to the economy—without upsetting long-run inflation
expectations.
• He called inflation targeting a policy of constrained discretion.
• Bernanke advocated that the Fed publish its inflation targets and make available its
own forecasts of inflation for the next two years.
• To preserve credibility over the long term, inflation targeting provided a structure to
policy that the private sector could understand.
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Extra Application 5
THE DEMOCRATS PLAYBOOK FOR BUSINESS
The election results are in and America voted for change and the Democratic majority has a
full slate of macroeconomic issues to tackle. According to various prognosticators some of
the more pressing issues we are likely to see addressed in 2007 are an increase in the
minimum wage and some legislation giving Congress the ability to negotiate prescription
drug prices with pharmaceutical companies.
• Other hot button issues include guest worker programs for immigrants and trade
issues that involve greater environment and labor protections.
• Big oil companies may not fare well with repeals of tax breaks likely and certain tax
changes designed to repeal benefits targeting high income households while
providing more breaks for the middle class.
• Sarbanes-Oxley reform and tort reform are also likely targets designed to make U.S.
business more competitive.
• Other issues include deficit reduction and increased spending on education and
alternative-energy research.
As you can see there are dozens of worthy projects that need governmental attention.
Can they do it all? Time will tell how far Congress gets on this very aggressive agenda.
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17.3
SHOULD WE TAX CONSUMPTION
RATHER THAN INCOME?
• consumption taxes
Taxes based on the consumption,
not the income, of individuals.
Two Debates About Consumption Taxation
DEBATE 1: WILL CONSUMPTION TAXES LEAD TO MORE
SAVINGS?
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Extra Application 4
FRENCH CONSUMER SPENDING DROPS SHARPLY
French consumers spent less money in September as consumer spending on
manufactured goods fell by 2.7 percent over the previous month. The decline was the
largest fall in nearly ten years and casts doubt on the recent supposed upswing in
consumer spending. While many economists expected a correction from the strong 3.0
percent increase posted in August, most did not expect this magnitude.
• The primary consumer goods taking the hit were textiles and leather goods, a
category that fell by nearly 10 percent.
• While spending was down for the month, the quarterly data continue to support
modest economic growth.
Marginal Propensity to Consume (MPC)
Marginal Propensity to Save (MPS)
MPC + MPS = 1
Consumers either spend, or save, each dollar of
income. The fraction of the next dollar (or Euro in
this case) that is consumed or spent is known as
the marginal propensity to consume or MPC. The
fraction of the next Euro saved is known as the
marginal propensity to save or MPS.
Consumer spending is one of the primary
components of aggregate expenditures.
Consumption, business investment,
government spending and net exports all
represent the major categories that drive
the economy. If consumption falls and the
other components do not increase by
enough to offset the decline, then overall
economic growth will fall as well.
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17.3
SHOULD WE TAX CONSUMPTION
RATHER THAN INCOME?
Two Debates About Consumption Taxation
DEBATE 2: ARE CONSUMPTION TAXES FAIR?
• capital gains
Profits investors earn when they
sell stocks, bonds, real estate,
or other assets.
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THE FLAT TAX IS A TAX ON CONSUMPTION
APPLYING THE CONCEPTS #3: What type of tax is the “flat tax”?
The “flat tax” brings the personal income tax and
corporate income tax into a single, unified tax system.
• One low, single tax rate applies to both businesses and individuals.
• Wage payments are deducted by businesses before they pay taxes.
• Would allow businesses to deduct any investment spending they make
from their income before the tax is calculated.
• Can essentially be viewed as a type of consumption tax.
The flat tax has an important feature that ensures that wealthy individuals
still pay taxes.
• Example: 14 million iPods were shipped in 2006.
• Profit for each iPod: $100
• Total profit: $1.4 billion
• Under this version of the flat tax, these extraordinary gains would be taxed in full.
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capital gains
government expenditures
consumption taxes
monetizing the deficit
deficit
Ricardian equivalence
government debt
surplus
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