AP Economics
Mr. Bernstein
Module 30:
Long-Run Implications of Fiscal Policy:
Deficits and the Public Debt
February 12, 2015
AP Economics
Mr. Bernstein
Long-Run Implications of Fiscal Policy
• Objectives - Understand each of the following:
• Why governments calculate the cyclically adjusted
budget balance
• Why a large public debt may be a cause for concern
• Why implicit liabilities of the government are also a
cause for concern
2
AP Economics
Mr. Bernstein
Budget Deficits: Good or Bad?
• Normative question
3
AP Economics
Mr. Bernstein
The Budget Balance: a Measure of Fiscal Policy
• Sgovernment =T – G – Transfers
• Expansionary Policies in T, G or Transfers reduce
Budget Balance
• Contractionary Policies in T, G or Transfers
increase Budget Balance
• G has greater impact than T or Transfers
• Changes in budget balance often result from,
rather than create, changes in the economy
4
AP Economics
Mr. Bernstein
The Cyclically Adjusted Budget Balance
• Strong relationship between budget balance and
business cycle
• Why?
5
AP Economics
Mr. Bernstein
The Cyclically Adjusted Budget Balance, cont.
• Cyclically Adjusted Budget Balance separates impact
due to deliberate policy from impact due to the
current state of the business cycle
• Is an estimate of what the Budget Balance would be
if real GDP = potential output
• After adjusting for current state of business cycle the
government is still running a deficit, policies are not
sustainable
6
AP Economics
Mr. Bernstein
The Cyclically Adjusted Budget Balance
7
AP Economics
Mr. Bernstein
Should the Budget be Balanced?
• Annually balanced budgets would require
• Cutting spending or increasing taxes in a recession
• Decreasing taxes or increasing spending in inflationary
gap
• Would this help?
• Most economists believe budgets should be
balanced on the average, not annually
• Favor using Cyclically Balanced Budgets
• Political pressure creates difficulty
8
AP Economics
Mr. Bernstein
Deficits, Surpluses and Debt
• Governments typically borrow to cover deficits
• This creates Public Debt
• US Public Debt: http://www.usdebtclock.org/
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Public Debt “Crowds Out” Private Borrowing
Reduces flexibility of future budgets
Borrowing more…could lead to ugly default
Raising taxes, cutting spending…unpopular
Printing money…risks inflation
9
AP Economics
Mr. Bernstein
Debt-to-GDP Ratio
• Measures government ability to pay down debt
10
AP Economics
Mr. Bernstein
Implicit Liabilities
• Government promises not included in debt stats
• Social Security
• Medicare
• Medicaid
• Many will change with demographics
11