Transcript Chapter 17

Chapter 17
Macroeconomic
Policy Debates
We all know that our nations are
faced with great economic
challenges.
Prepared By Brock Williams
Learning Objectives
1. List the benefits and the costs for a country
of running a deficit.
2. Summarize the arguments in favor of
inflation targeting.
3. Describe the key differences between
income and consumption taxes.
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17-2
17.1 SHOULD WE BALANCE THE
FEDERAL BUDGET?
The Budget in Recent Decades
► FIGURE 17.1
Debt as a Percent of GDP,
1791–2011
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
and since 2008.
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17-3
17.1 SHOULD WE BALANCE THE
FEDERAL BUDGET?
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.
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17-5
17.1 SHOULD WE BALANCE THE
FEDERAL BUDGET?
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
● Ricardian equivalence
The proposition that it does not matter whether
government expenditure is financed by taxes or debt.
PRINCIPLE OF OPPORTUNITY COST
The opportunity cost of something is what you sacrifice to get it.
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17-8
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, 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.
SOURCE: Central Intelligence Agency, The
World Factbook,
https://www.cia.gov/library/publications/theworld-factbook/
index.html (acceessed November 19, 2012) .
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17-9
17.1 SHOULD WE BALANCE THE
FEDERAL BUDGET?
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?
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17-10
17.1 SHOULD WE BALANCE THE
FEDERAL BUDGET?
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.
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17-12
17.1 SHOULD WE BALANCE THE
FEDERAL BUDGET?
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.
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17-13
17.2 SHOULD THE FED TARGET BOTH
INFLATION AND UNEMPLOYMENT?
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.
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17-14
17.2 SHOULD THE FED TARGET BOTH
INFLATION AND UNEMPLOYMENT?
Two Debates About Inflation Targeting
DEBATE 1: SHOULD THE FED FOCUS ON ONLY INFLATION?
•Conducting the nation's monetary policy by influencing money and
credit conditions in the economy in pursuit of full employment and
stable prices.
•Supervising and regulating banks and other important financial
institutions to ensure the safety and soundness of the nation's banking
and financial system and to protect the credit rights of consumers.
•Maintaining the stability of the financial system and containing
systemic risk that may arise in financial markets.
•Providing certain financial services to the U.S. government, U.S.
financial institutions, and foreign official institutions, and playing a
major role in operating and overseeing the nation's payments
systems.
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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.
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17-16
17.2 SHOULD THE FED TARGET BOTH
INFLATION AND UNEMPLOYMENT?
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.
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17-17
17.3 SHOULD WE TAX CONSUMPTION
RATHER THAN INCOME?
Two Debates About Consumption Taxation
DEBATE 1: WILL CONSUMPTION TAXES LEAD
TO MORE SAVINGS?
● consumption taxes
Taxes based on the consumption, not the
income, of individuals.
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.
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17.3 SHOULD WE TAX CONSUMPTION
RATHER THAN INCOME?
Two Debates About Consumption Taxation
DEBATE 2: ARE CONSUMPTION TAXES FAIR?
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.
● capital gains
Profits investors earn when they sell stocks,
bonds, real estate, or other assets.
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17-19
17.3 SHOULD WE TAX CONSUMPTION
RATHER THAN INCOME?
Two Debates About Consumption Taxation
DEBATE 2: ARE CONSUMPTION TAXES FAIR?
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KEY
TERMS
capital gains
monetizing the deficit
consumption taxes
Ricardian equivalence
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Questions?
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