Transcript Macroeconomic Policy Debates

C H A P T E R 17
Macroeconomic Policy
Debates
Copyright © 2012 Pearson
Prentice
Hall.
All rights
reserved.
Copyright
© 2012
Pearson
Prentice
Hall. All rights reserved.
17-1
CHAPTER
Macroeconomic Policy
Debates
17
Economists are often cautious and try to warn policymakers that
carrying out effective economic policy is difficult.
PREPARED BY
Brock Williams
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
C H A P T E R 17
Macroeconomic Policy
Debates
APPLYING THE CONCEPTS
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
Did the Federal Reserve cause the housing boom through
excessively loose monetary policy?
Would a Policy Rule Have Prevented the Housing Boom?
3
Can the United States adopt a European-style value-added tax?
Is a VAT in Our Future?
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
17-3
C H A P T E R 17
Macroeconomic Policy
Debates
17.1
SHOULD WE BALANCE THE FEDERAL
BUDGET?
The Budget in Recent Decades
► FIGURE 17.1
Debt as a Percent of GDP,
1791–2009
The nation’s debt/GDP
ratio tends to rise sharply
during wars because more
spending is needed to
finance them.
However, the ratio also can
rise during peacetime, as it
did during the Reagan
presidency in the 1980s.
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
17-4
C H A P T E R 17
Macroeconomic Policy
Debates
17.1
SHOULD WE BALANCE THE FEDERAL
BUDGET? (cont’d)
The Budget and Social Security
•Federal budget figures include revenue and expenditures from the Social Security
system. Over the next decade, the Social Security portion of the budget is expected to
run a surplus because of the huge number of baby boomers (those born between 1946
and 1964) currently paying taxes into the system.
•That surplus won’t last forever, though. Some economists argue that Social Security
funds should not be included in federal budget figures because the money will be
needed to make future Social Security payments to these baby boomers.
•Over the longer horizon, the surpluses in the Social Security account will disappear
and turn to deficits.
•As our society grows older, spending on both Social Security and Medicare will
increase.
•That increase in spending is causing the CBO to predict emerging federal deficits and
sharp increases in the debt/GDP ratio to levels comparable to those of World War II,
unless taxes are raised and/or spending is cut significantly.
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
17-5
C H A P T E R 17
Macroeconomic Policy
Debates
17.1
SHOULD WE BALANCE THE FEDERAL
BUDGET? (cont’d)
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.
Large, stable countries like the United Kingdom, the United States, and Japan
don’t monetize much of their debt because they are able to borrow from the
public. In these countries, deficits do not lead inevitably to inflation.
During the recent recession, the Fed purchased massive amounts of bonds,
but paid banks interest thus inducing them to hold additional reserves. This
prevented a large increase in the money supply held by the public.
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
17-6
C H A P T E R 17
Macroeconomic Policy
Debates
17.1
SHOULD WE BALANCE THE FEDERAL
BUDGET? (cont’d)
Five Debates About Deficits
DEBATE 2: IS GOVERNMENT DEBT A BURDEN ON
FUTURE GENERATIONS?
The result of government deficits is that less savings are available
to firms for investment.
Higher taxes will be imposed on future generations
PRINCIPLE OF OPPORTUNITY COST
The opportunity cost of something is what you sacrifice to get it.
● Ricardian equivalence
The proposition that it does not matter whether
government expenditure is financed by taxes or debt.
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
17-7
C H A P T E R 17
Macroeconomic Policy
Debates
17.1
SHOULD WE BALANCE THE FEDERAL
BUDGET? (cont’d)
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, 2009
Among developed countries,
the United States has a
relatively small percentage of
debt to GDP.
Japan has the highest
percentage of debt of the
countries depicted.
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
17-8
C H A P T E R 17
Macroeconomic Policy
Debates
17.1
SHOULD WE BALANCE THE FEDERAL
BUDGET? (cont’d)
Five Debates About Deficits
DEBATE 3: HOW DO DEFICITS AFFECT THE SIZE
OF GOVERNMENT?
Nobel Laureate James Buchanan has argued that people are less aware of
government deficits than of the taxes they’re forced to pay.
Therefore, financing government expenditures through deficits, rather than through
higher taxes, will inevitably lead to higher government spending and bigger
government.
Although this argument may seem plausible, it presents two problems:
First, in recent U.S. history, spending by state and local governments has
grown much faster than federal spending. However, state and local
governments face many more restrictions when it comes to borrowing money
than the federal government faces.
Second, if politicians trying to get reelected really prefer higher government
spending and deficits to higher taxes and surpluses, why did the federal
government run surpluses in the late 1990s?
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
17-9
C H A P T E R 17
Macroeconomic Policy
Debates
APPLICATION
1
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 U.S.
•As the population ages, life expectancies increase, and health-care costs
continue to grow, expenditures on Social Security and Medicare are expected to
increase significantly, too.
•Over time, there will be an escalating gap between revenues and expenditures,
which will have to be met by outright borrowing.
•Economists Jagadeesh Gokhale of the Cato Institute and Kent Smetters of the
University of Pennsylvania have developed a method for 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” is approximately $63 trillion, or five times GDP.
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
17-10
C H A P T E R 17
Macroeconomic Policy
Debates
17.1
SHOULD WE BALANCE THE FEDERAL
BUDGET? (cont’d)
Five Debates About Deficits
DEBATE 4: CAN DEFICITS BE GOOD FOR AN
ECONOMY?
The government may deliberately run a deficit to pull the economy out
of a recession. The deficit the government creates puts additional
income into the hands of the public.
With more money, people don’t have to drastically cut their consumption
spending. Because total spending in the economy does not fall as
much, the severity of the recession is lessened.
Deficits can also play a role in tax smoothing during periods of
unusually high government expenditures.
By running deficits and only gradually raising taxes later to service the
debt, we avoid creating excess distortions in the economy.
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
17-11
C H A P T E R 17
Macroeconomic Policy
Debates
17.1
SHOULD WE BALANCE THE FEDERAL
BUDGET? (cont’d)
Five Debates About Deficits
DEBATE 5: WOULD A BALANCED-BUDGET
AMENDMENT REALLY WORK?
Proponents of the balanced-budget amendment say it will finally exert
discipline on the federal government, preventing large deficits in
peacetime, such as those that occurred in the 1980s.
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.
• Congress could also find nonbudgetary ways to carry out the policies
that it desires.
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
17-12
C H A P T E R 17
Macroeconomic Policy
Debates
17.2
SHOULD THE FED TARGET INFLATION OR
PURSUE OTHER OBJECTIVES?
Two Debates About Inflation Targeting
DEBATE 1: SHOULD THE FED FOCUS ON ONLY INFLATION?
We have learned that in the long run, monetary policy can influence only the
level of prices, not the level of employment. Proponents of inflation targeting
argue that the Fed should have only one primary goal: controlling inflation.
Before he took over as chairman of the Federal Reserve in 2006, Ben Bernanke
was an advocate for inflation targeting. Bernanke called inflation targeting a
policy of constrained discretion. Under inflation targeting, the Fed could take
actions to offset shocks to real output or to the financial system, but it had to
keep its long-run inflation targets in clear view.
However, many economists disagree with the idea of inflation targeting because
they strongly object to the Fed concentrating solely on controlling inflation.
Economists also debate the level for an inflation target. It is very difficult to
measure changes in prices accurately when there is a great deal of technological
change occurring in the economy.
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
17-13
C H A P T E R 17
Macroeconomic Policy
Debates
APPLICATION
2
WOULD A POLICY RULE HAVE PREVENTED THE
HOUSING BOOM?
APPLYING THE CONCEPTS #2: Did the Federal Reserve cause
the housing boom through excessively loose monetary policy?
•John Taylor of Stanford argued that the Fed’s “easy money” policy
from mid-2001 through 2004 was responsible for the housing boom.
•The Fed lowered interest rates from 2 percent in 2001 to 1 percent
in 2004. Using the Taylor Principle, he found they should have raised
it to 4 percent.
•He showed that housing starts, which are very sensitive to interest
rates would have been much lower and the boom and bust would
have been avoided.
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
17-14
C H A P T E R 17
Macroeconomic Policy
Debates
17.2
SHOULD THE FED TARGET INFLATION OR
PURSUE OTHER OBJECTIVES? (cont’d)
Two Debates About Inflation Targeting
DEBATE 2: IF THERE WERE AN INFLATION TARGET, WHO
WOULD SET IT?
In the United Kingdom, which adopted targeting in 1992, the
elected government decides on the inflation target for the central
bank.
In other countries, the central bank has more influence in setting
the inflation target.
Under current law, the Fed chairman reports regularly to
Congress, but the Fed has considerable power to use monetary
policy to stabilize output as well as to fight inflation as it pleases.
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
17-15
C H A P T E R 17
Macroeconomic Policy
Debates
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?
There is no question that taxing consumption instead of savings
creates an incentive to save. However, there’s no guarantee the
incentive will actually result in more money saved in the economy.
People will want to take advantage of this incentive and reduce
consumption and increase savings. On the other hand, people will
also want to spend more because, with the tax cut, they are
wealthier.
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
17-16
C H A P T E R 17
Macroeconomic Policy
Debates
17.3
SHOULD WE TAX CONSUMPTION
RATHER THAN INCOME? (cont’d)
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.
In practice, moving to a consumption-tax system could have a
major impact on the distribution of income in the economy.
Suppose we simply exempted the returns from savings from the
income tax.
This exception would clearly favor wealthy and high-income
individuals who save the most and earn a lot of income in interest,
dividends, rents, and capital gains.
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
17-17
C H A P T E R 17
Macroeconomic Policy
Debates
17.3
SHOULD WE TAX CONSUMPTION
RATHER THAN INCOME? (cont’d)
Two Debates About Consumption Taxation
DEBATE 2: ARE CONSUMPTION TAXES FAIR?
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
17-18
C H A P T E R 17
Macroeconomic Policy
Debates
APPLICATION
3
IS A VAT IN OUR FUTURE?
APPLYING THE CONCEPTS #3: Can the United States
adopt a European-style value-added tax?
•Virtually all developed countries use a value-added tax; a VAT. The United
States is a prominent exception.
•A VAT is essentially a sales tax added at each stage of production. It is
embedded and easy to collect, however it tends to be high; 17.5 percent in the
United Kingdom.
•A VAT would be regressive and might impinge on state taxing authority.
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
17-19
C H A P T E R 17
Macroeconomic Policy
Debates
KEY TERMS
capital gains
monetizing the deficit
consumption taxes
Ricardian equivalence
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
17-20