Transcript module 30 ppt

Module 30:
Long-run Implications of Fiscal Policy:
Deficits and the Public Debt
1
Fiscal Policy Revisited
• Recessionary Gap
– The gap that exists
whenever equilibrium
real GDP per year is
less than fullemployment real GDP
as shown by the
position of the LRAS
curve.
Fiscal Policy Revisited
• Inflationary Gap
– The gap that exists
whenever equilibrium
real GDP per year is
greater than fullemployment real GDP
as shown by the
position of the LRAS
curve.
Fiscal Policy Revisited
• Fiscal Policy—the discretionary changes in
government expenditures and/or taxes in order
to achieve the national economic goals of:
– High employment (low unemployment)
– Price stability
– Economic growth
Fiscal Policy Revisited
• Assume there is a recessionary gap
 Expansionary fiscal policy can
close the recessionary gap.
 Increase government spending
 Decrease taxes
 Direct and indirect effects
cause the aggregate demand
curve to shift outward.
Fiscal Policy Revisited
• Assume there is a inflationary gap
 Contractionary fiscal policy can
close the recessionary gap.
 Decrease government spending
 Increase taxes
 Direct and indirect effects
cause the aggregate demand
curve to shift inward.
The Budget Balance
• Other things equal, expansionary fiscal
policies (i.e. government purchases of
goods/services, higher government transfers,
or lower taxes) reduce the budget balance for
that year.
• Other things equal, contractionary fiscal
policies (i.e. reduced government purchases,
lower government transfers, or higher taxes)
increase the budget balance for that year.
The Budget Balance
• Budget Balance
– The difference between the government’s tax
revenue and its spending in a given year.
• Government Budget Deficit
– Negative budget balance
• Government Budget Surplus
– Positive budget balance
The Budget Balance—
Federal Government Deficits and Surpluses since 1940
The Federal Budget Deficit
Expressed as a Percentage of GDP
The Business Cycle and the
Cyclically Adjusted Budget Balance
 Historically, the budget tends to move into deficit when the
economy experiences a recession, but the deficits shrink or
turn into surpluses when the economy is expanding.
The Business Cycle and the
Cyclically Adjusted Budget Balance
 The relationship is even clearer if we compare the budget
deficit as a percentage of GDP with the unemployment rate.
The Cyclically Adjusted Budget Balance
• In assessing budget policy, we need to separate
movements in the budget balance due to the
business cycle…
– Caused by automatic stabilizers.
– Effects are temporary and tend to be eliminated in
the long-run.
The Cyclically Adjusted Budget Balance
• …from the movements in the budget balance
due to discretionary fiscal policy changes.
– Caused by deliberate changes in government
purchases, transfers or taxes.
– When we remove the cyclical effects, this sheds
light on whether the government’s taxing and
spending policies are sustainable in the long-run.
The Cyclically Adjusted Budget Balance
• It is an estimate of what the budget balance would be
if real GDP were exactly equal to potential output.
Should the Budget Be Balanced?
• Politicians are always tempted to run deficits because
this allows them to cater to voters by cutting taxes
without cutting spending or by increasing spending
without increasing taxes.
• Most economists don’t believe the government
should be forced to run a balanced budget every year
because this would undermine the role of taxes and
transfers as automatic stabilizers.
Problems Posed by Government Deficits
1. In the short run, deficits can have two
potentially damaging effects on the economy
a. If the economy is at full employment, a
government deficit is inflationary.
b. Deficits raise interest rates which can retard growth
in investment and housing activities.
2. In the long run, deficits can add to a rising
government debt.
Problems Posed by Rising Government Debt
• For 2012, the U.S. federal government had total
debt equal to $16.43 trillion.
1. A large federal debt puts financial pressure on
future budgets
2. If a large portion of the debt is held by other
countries, then foreigners have a large claim on
U.S. resources
•
About half our “public debt” is owned by foreign
investors, the largest of which were China and Japan at
just over $1.1 trillion each.
3. If the national debt rises at a rate faster than GDP,
then this can have negative ramifications for the
future growth potential of the U.S.
Deficits and Debts in Practice
• Although we haven’t balanced deficits with
surpluses, these deficits have not led to
runaway debt.
• To assess the ability of governments to pay
their debt, we often use the debt-GDP ratio
– If the government’s debt grows more slowly than
GDP, the burden of paying that debt is actually
falling.
– Although the federal debt has grown in almost
every year, the debt-GDP ratio fell for 30 years after
the end of WWII.
Deficits and Debts in Practice
• Comparing panels (a) and (b), you can see that
in many years the debt-GDP ratio has declined
in spite of government deficits.
Deficits and Debts in Practice
• Still, a government that runs persistent large
deficits will have a rising debt-GDP ratio when
debt grows faster than GDP.
Deficits and Debts in Practice
• Our deficit for 2012 was $1.089 trillion
• Our public debt at the end of 2012 was $11.59 trillion.
• Our GDP for 2012 was $15.86 trillion.
– Budget deficit as a percent of GDP: 6.8%
– Public debt-GDP ratio: 73%
• A recent study reported that among the 20 advanced
countries studied, average annual GDP growth was 3–
4% when debt was relatively moderate or low (i.e.
under 60% of GDP), but it dips to just 1.6% when debt
was high (i.e., above 90% of GDP).
Implicit Liabilities
• Despite our steady debt-GDP ratio, some experts on
long-run budget issues view the situation in the U.S.
with alarm due to implicit liabilities.
– Spending promises made by governments that
represent a future debt but are not included in the
usual debt statistics (i.e. transfer payments).
– Social Security, Medicare and Medicaid currently
account for almost 40% of federal spending.
Implicit Liabilities
• For this reason, many economists argue that the total federal
debt of $15 trillion, the sum of public debt and government
debt held by Social Security and other trust funds, is a more
accurate indication of the government’s fiscal health than the
smaller amount owed to the public alone.