30 McGrawHillIrwin Copyright 2012 by The McGrawHill Companies Inc All rights reserved Fiscal Policy Deliberate changes in Government spending Taxes Designed to Achieve fullemployment ID: 254579
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Fiscal Policy, Deficits, and Debt
30
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.Slide2
Fiscal Policy
Deliberate changes in:Government spending
TaxesDesigned to:
Achieve full-employmentControl inflationEncourage economic growth
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2Slide3
Expansionary Fiscal Policy
Use during a recessionIncrease government spending
Decrease taxesCombination of both
Create a deficit
LO1
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3Slide4
Expansionary Fiscal Policy
Real GDP (billions)
Price level
AD
2
AD
1
$5 billion
increase in
spending
Full $20 billion
increase in
aggregate demand
AS
$490
$510
P
1
LO1
Recessions
Decrease AD
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4Slide5
Contractionary Fiscal Policy
Use during demand-pull inflationDecrease government spending
Increase taxesCombination of both
Create a surplus
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5Slide6
Contractionary Fiscal Policy
Real GDP (billions)
Price level
AD
3
AD
4
$3 billion initial
decrease in
spending
Full $12 billion
decrease in
aggregate demand
AS
$502
$
522
P
2
AD
5
$
510
d
b
a
P
1
c
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6Slide7
Policy Options: G or T?
To expand the size of governmentIf recession, then increase government spending
If inflation, then increase taxesTo reduce the size of government
If recession, then decrease taxesIf inflation, then decrease government spending
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Built-In Stability
Automatic stabilizersTaxes vary directly with GDP
Transfers vary inversely with GDPReduces severity of business fluctuations
Tax progressivityProgressive tax systemProportional tax systemRegressive tax system
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Built-In Stability
G
T
Deficit
Surplus
GDP
1
GDP
2
GDP
3
Real domestic output, GDP
Government expenditures, G,
and tax revenues, T
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9Slide10
Evaluating Fiscal Policy
Is the fiscal policy…Expansionary?
Neutral?Contractionary?
Use the cyclically adjusted budget to evaluate
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10Slide11
Cyclically Adjusted Budgets
G
T
GDP
2
GDP
1
Real domestic output, GDP
Government expenditures, G, and
tax revenues, T (billions)
(year 2)
(year 1)
$500
450
a
b
c
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11Slide12
Cyclically Adjusted Budgets
G
T
1
GDP
4
GDP
3
Real domestic output, GDP
Government expenditures, G, and
tax revenues, T (billions)
(year 4)
(year 3)
$500
450
d
e
f
475
425
g
T
2
h
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12Slide13
Recent U.S. Fiscal Policy
Federal Deficits (-) and Surpluses (+) as Percentages of GDP, 2000-2009
(1)
Year
(2)ActualDeficit – or
Surplus +
(3)
Cyclically
Adjusted
Deficit – or
Surplus +*
2000
+2.4
+1.1
2001
+1.3
+0.5
2002
-1.5
-1.3
2003
-3.4
-2.7
2004
-3.5
-3.2
2005
-2.6
-2.5
2006
-1.9
-2.0
2007
-1.2
-1.2
2008
-3.2
-2.8
2009
-9.9
-7.3
As a percentage of potential GDP
Source
: Congressional Budget Office,
http://www.cbo.gov
.
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Fiscal Policy: The Great Recession
Financial market problems began in 2007Credit market freeze
Pessimism spreads to the overall economyRecession officially began December 2007 and lasted 18 months
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14Slide15
Budget Deficits and Projections
Source
: Congressional Budget Office,
http://www.cbo.gov
.
$200
0
-200
-400
-600
-800
-1000
-1200
-1400
-1600
Budget Deficit (-) or Surplus, Billions
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
Actual
Projected
(as of March 2010)
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Global Perspective
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Problems, Criticisms, & Complications
Problems of TimingRecognition lag
Administrative lagOperational lag
Political business cyclesFuture policy reversalsOff-setting state and local financeCrowding-out effect
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Current Thinking on Fiscal Policy
Let the Federal Reserve handle short-term fluctuationsFiscal policy should be evaluated in terms of long-term effects
Use tax cuts to enhance work effort, investment, and innovationUse government spending on public capital projects
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The U.S. Public Debt
$11.9 trillion in 2009The accumulation of years of federal deficits and surpluses
Owed to the holders of U.S. securitiesTreasury bills
Treasury notesTreasury bondsU.S. savings bonds
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The U.S. Public Debt
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Debt held outside
the Federal
government and the
Federal Reserve:
57%
Debt held by
the Federal
government and the
Federal Reserve:
43%
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20Slide21
The U.S. Public Debt
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Global Perspective
Public Sector Debt as
Percentage of GDP, 2009
Italy
JapanGreeceBelgiumFranceUnited States
France
Germany
United Kingdom
Spain
Netherlands
Canada
0 20 40 60 80 100
Source
: Organization for Economic Cooperation and Development,
OECD
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The U.S. Public Debt
Interest charges on debtLargest burden of the debt
1.3% of GDP in 2009False Concerns
BankruptcyRefinancingTaxationBurdening future generations
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Substantive Issues
Income distributionIncentives
Foreign-owned public debtCrowding-out effect revisitedFuture generations
Public investment
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Crowding-Out Effect
5
10
15
20
25
30
35
40
0
2
4
6
8
10
12
14
16
Real interest rate (percent)
Investment (billions of dollars)
ID
1
ID
2
a
b
c
Increase in
investment
demand
Crowding-out
effect
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Social Security, Medicare Shortfalls
More Americans will be receiving benefits as they ageSocial security shortfalls
Income during retirementFunds will be depleted by 2037
Medicare shortfallsMedical care during retirementFunds will be depleted by 2017
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Social Security, Medicare Shortfalls
Possible options “to fix” include:Increasing the retirement age
Increasing the portion of earnings subject to the social security taxDisqualifying wealthy individuals
Redirecting low-skilled immigrants to higher-skilled, higher paying workDefined contribution plans owned by individuals
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