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Fiscal Policy, Deficits, and Debt Fiscal Policy, Deficits, and Debt

Fiscal Policy, Deficits, and Debt - PowerPoint Presentation

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Fiscal Policy, Deficits, and Debt - PPT Presentation

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

policy gdp lo4 government gdp policy government lo4 fiscal debt federal public tax real increase lo1 decrease billions budget

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Slide1

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

LO1

30-

2Slide3

Expansionary Fiscal Policy

Use during a recessionIncrease government spending

Decrease taxesCombination of both

Create a deficit

LO1

30-

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

30-

4Slide5

Contractionary Fiscal Policy

Use during demand-pull inflationDecrease government spending

Increase taxesCombination of both

Create a surplus

LO1

30-

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

LO1

30-

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

LO1

30-

7Slide8

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

LO2

30-

8Slide9

Built-In Stability

G

T

Deficit

Surplus

GDP

1

GDP

2

GDP

3

Real domestic output, GDP

Government expenditures, G,

and tax revenues, T

LO2

30-

9Slide10

Evaluating Fiscal Policy

Is the fiscal policy…Expansionary?

Neutral?Contractionary?

Use the cyclically adjusted budget to evaluate

LO3

30-

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

LO3

30-

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

LO3

30-

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

.

LO3

30-

13Slide14

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

LO4

30-

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)

LO4

30-

15Slide16

Global Perspective

LO4

30-

16Slide17

Problems, Criticisms, & Complications

Problems of TimingRecognition lag

Administrative lagOperational lag

Political business cyclesFuture policy reversalsOff-setting state and local financeCrowding-out effect

LO4

30-

17Slide18

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

LO4

30-

18Slide19

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

LO4

30-

19Slide20

The U.S. Public Debt

LO4

Debt held outside

the Federal

government and the

Federal Reserve:

57%

Debt held by

the Federal

government and the

Federal Reserve:

43%

30-

20Slide21

The U.S. Public Debt

LO4

30-

21Slide22

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

LO4

30-

22Slide23

The U.S. Public Debt

Interest charges on debtLargest burden of the debt

1.3% of GDP in 2009False Concerns

BankruptcyRefinancingTaxationBurdening future generations

LO4

30-

23Slide24

Substantive Issues

Income distributionIncentives

Foreign-owned public debtCrowding-out effect revisitedFuture generations

Public investment

LO4

30-

24Slide25

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

LO4

30-

25Slide26

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

30-26Slide27

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

30-27