Macro
McEachern
2011
ECON
13
2010-
CHAPTER
Designed by
Amy McGuire, B-books, Ltd.
Chapter 13
Federal
Budgets and
Public Policy
Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved
The Federal Budget Process
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Federal budget
Outlays
Government purchases
Transfer payments
Revenues
Specific period
Federal government – shifted focus
From national defense
To redistribution
LO1
Chapter 13
Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved
LO1
Exhibit 1
Defense’s Share of Federal Outlays Declined
Since 1960 and Redistribution Increased
Chapter 13
Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved
Presidential and
Congressional Roles
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The President
Budget proposal
Budget request from each agency
“The budget of U.S. government” to
Congress
Council of Economic Advisors
“Economic report of the President”
House and Senate
Budget committees: Budget resolution
LO1
Chapter 13
Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved
Presidential and
Congressional Roles
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Budget deficit: Outlays > Revenues
Stimulates AD in short run
Reduces national saving
Long run: hinder economic growth
Budget surplus: Revenues > Outlays
Dampens AD in short run
Boosts domestic saving
Long run: promote economic growth
LO1
Chapter 13
Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved
Problems with
Federal Budget Process
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Continuing resolutions
Instead of budget decisions
Lengthy budget process
Uncontrollable budget items
No separate capital budget
Overly detailed budget
LO1
Chapter 13
Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved
Fiscal Impact of the
Federal Deficits
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Rationale for deficits
Outlays that increase economy’s
productivity
Budget philosophies and deficits
Annually balanced budget
Cyclically balanced budget
Functional finance
LO2
Chapter 13
Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved
Fiscal Impact of the
Federal Deficits
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Federal deficits: since birth of the nation
1789-1930
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Deficit: 33% of years (war)
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Since the Great Depression
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Deficit: 85% of years
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1980s relatively large deficits
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Large tax cuts
High defense spending
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1990s: improved economy
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LO–2
Chapter 13
Decreasing deficits
By 1998: surplus
Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved
Fiscal Impact of the
Federal Deficits
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Federal deficits: since birth of the nation
2001 recession
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Tax cuts
Higher federal spending
Deficits
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Weak recovery
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War against terrorism
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2003, deficit 3.5% of GDP
2007 stronger economy
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Rising stock market
Deficit 1.2% of GDP
LO–
Chapter 13
2009 deficit of $1.8 trillion projected
Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved
LO2
Exhibit 2
After Decades of Federal Budget Deficits,
Surpluses Appeared from 1998 to 2001, But
Deficits Are Back
Chapter 13
Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved
Fiscal Impact of the
Federal Deficits
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LO2
Chapter 13
Why have deficits persisted?
Tax cuts
Spending increase
Federal officials
Not required to balance the budget
Elected officials
Big spending programs
Small taxes
Pork-barrel spending
Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved
Fiscal Impact of the
Federal Deficits
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Increase federal deficits
National saving – reduced
Interest rates – higher
Investment
Discouraged (crowding out)
Stimulated (crowding in)
LO2
Chapter 13
Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved
Fiscal Impact of the
Federal Deficits
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The twin deficits
Finance huge deficits
U.S. Treasury – sells IOUs
High interest rates
Greater demand for $
U.S. trade deficit increase
Foreigners buy U.S. assets
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Increase I
Decline S
LO2
Chapter 13
Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved
During the 1990s, Federal Outlays
Declined Relative to GDP and Revenues
Increased, Turning Deficits into Surpluses,
But Not for Long
Exhibit 3
LO2
Chapter 13
Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved
The National Debt
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National debt
Net accumulation of past deficits
Measuring the national debt
Gross debt
U.S. Treasury notes – by federal agencies
Debt held by the public
U.S. Treasury securities
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Households; Firms
Banks (include the Fed)
Foreign entities
LO3
Chapter 13
Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved
LO3
Exhibit 5
Federal Debt Held by the Public as a
Percentage of GDP Since 1940
Chapter 13
Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved
Relative to GDP, U.S. Net Public Debt in 2008
3
LO
Exhibit 6
Was Above Average for Major Economies
Chapter 13
Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved
The National Debt
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Interest on the national debt
Buyers of federal securities
Individuals, $25
Institutions, $1 million
Increasing interest rates
1 percentage point increase
in nominal interest rate
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Interest cost increase $58 billion
per year
LO3
Chapter 13
Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved
The National Debt
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Who bears the burden of debt?
Billing future taxpayers
For current spending
We owe it to ourselves
Future generations
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Service the debt
Receive the payments
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Foreign ownership of debt
Increase burden of debt
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Future generations of Americans
LO3
Chapter 13
Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved
Foreign Holders of U.S. Treasury
Securities
Exhibit 8
LO3
Chapter 13
Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved
The National Debt
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Crowding out and capital formation
Deficit spending, long run
Borrowed funds – invested in
public capital
Increased productivity
Increased standard of living
Borrowed funds – current
expenditures
Less capital formation
LO3
Chapter 13
Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved
The National Debt
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LO3
Chapter 13
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Intergenerational view of deficits and
debt
Welfare of generations
Tied together
Parents now
Consume less
Save more
Reduce the burden on next
generation
Issues
People with no children
Informed of federal spending
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Case Study
LO3 An Intergenerational View of Deficits and Debt
 Barro model
 assumes parents are concerned
about the welfare of their
children, who, in turn,
 are concerned about the welfare
of their children
 and so on for generations.
Chapter 13
Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved
Case Study
LO3 An Intergenerational View of Deficits and Debt
 Barro: Parents can reduce the
burden of the federal debt on future
generations by
 consuming less
 saving more
Chapter 13
Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved
Case Study
LO3 An Intergenerational View of Deficits and Debt
 As governments substitute deficits for
taxes, parents consume less/save more to
increase gifts/bequests to their children.
 If greater saving offsets federal deficits,
deficit spending will not increase AD
because the decline in consumption will
negate the fiscal stimulus provided by
deficits.
 This offsets future burden of higher debt
and neutralizes effect of deficit spending on
AD, output, and employment.
Chapter 13
Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved
Case Study
LO3 An Intergenerational View of Deficits and Debt
 Critics:
 The evidence fails to support his theory
because large federal deficits coincided
with lower, not higher, saving rates.
 Those with no children may be less
concerned about the welfare of future
generations.
 Theory assumes people are aware of
federal spending and tax policies and
about the future consequences of
current policies.
Chapter 13
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