Transcript Module 30: Long-Run Implications of Fiscal Policy

Module 30: LongRun Implications of
Fiscal Policy
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Deficits and the Public Debt
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Juice box bonus is due 3 Dec
If you would like to do a white elephant we
need to talk about it:
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It will be a slight economic experiment (and fun)
We will see who can get the best deal on
something for the set price
The person who gets the best “deal” according to
the class, wins
Announcements
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It’s a quick measure of whether the economy is
expansionary or contractionary but there are
two reasons why this can be misleading:
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Changes in fiscal policy do not always have the
same effect
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i.e. gov’t purchases have a much larger effect on
rGDP than equal-sized changes in taxes and
transfers
Changes in the budget balance are the result of
fluctuations in the economy
Is the Balanced Budget a
Good Measure of the
Economy?
Cyclically Adjusted Budget
Balance
(recession)= d deficit
 E economy (expansion) = d deficit (sometimes
surplus)
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E economy
Unemployment and Budgets
I deficit = r unemployment
 I deficit = r unemployment
 Why?
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Largely b/c automatic stabilizers kick in with recession and
reduce with expansion
The Federal Government should
be required to always maintain a
balanced budget.
Four-Corner Debate
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Most economists believe its only
necessary on average
Run a deficit on bad years and surplus
on good years
 Forcing it to happen every year was
negate the automatic stabilizers and
taxes
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Tax revenue I and transfers I helps to
reduce size of recessions
Balance the Budget?
Closer look at Germany
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Tried with social spending in 1919 but the amount they were paying per citizen
was far higher than what they were taking in so they took out loans
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The failure of the German economy was not due to debt though, much of it was
because they could not get their budgets in order and it led to spiraling deficit
spending
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In 1913 – 53% of all tax revenues was from income
By 1925 – that was 28%
But this wasn’t all – the German could not sell goods to foreign countries because
of protective tariffs placed on German goods
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1913 – 20.5 marks per person
1925 – 65 marks per person
1929 – over 100 marks per person
So they were attempting to sell goods to people in their country who had no
money
This will all lead to them printing excess money which is what everyone realizes
is the inflation of the German economy
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This lead to money hoarding or money destruction which forced the Weimar
Republic to print more money
Leading to a cyclical deflation of money and skyrocketing gov’t deficit that
threatened to collapse Germany
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Dawes Plan 1924
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Negotiations between the United States and Germany for a plan to coordinate
payments on debts and make the deficit more manageable
Reduced payments until 1929 when it was to be reevaluated
Reparations payments in 1922 were $2 billion but in 1924, they were set at $50
million
This was combined with a loan of $200 million from the US gov’t to improve
infrastructure
Helped to stabilize the economy
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Forced Germany to put checks and fiscal measures into place to keep inflation and
exchange rates at acceptable levels
Gold reserve was set to 30% of all money in circulation
By 1927 the Weimar Republic felt comfortable putting guarantees of
income for low earners in place (one of those automatic stabilizers)
Seemed to lead to an economic recovery, from 1924-1929 the cost of living
fell and the standard of living rose
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Industrial output had doubled by 1929 and the Germans were able to start
repaying reparations
But then the Depression hit and damaged a lot of this growth as the US
started to call in the loans it had just made 5 years earlier
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Debt – GDP ratio tells
economists how well the gov’t
can pay back debt
Dangerous when debt grows
faster than GDP
 Possible to run a deficit for many
years as long as the GDP is rising
faster than the debt
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Deficits and Debt in
Practice
US Budget Deficit
Japanese Budget Deficit
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Spending promises made by gov’ts that are
effectives a debt despite the fact that they are
not included in the usual debt statistics
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Ex:
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Social Security
Medicare
Medicaid
Implicit Liabilities
Social Security should be eliminated.
Four-Corner Debate