Chapter 30
Fiscal Policy,
Deficits, and
Debt
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter Objectives
• Purposes, tools, and limitations of
fiscal policy
• Built-in stabilizers and the business
cycle
• The standardized budget and U.S.
fiscal policy
• U.S. public debt
30-2
Fiscal Policy
• Council of Economic Advisers
(CEA)
• Discretionary fiscal policy
–Eliminate recessionary or
inflationary gap
–Countercyclical
• Nondiscretionary fiscal policy
–Passive or automatic
30-3
Fiscal Policy
• Expansionary fiscal policy
–Increased spending and/or lower
taxes
–Budget deficit
• Contractionary fiscal policy
–Lower spending and/or higher
taxes
–Budget surplus
• Policy options?
30-4
Expansionary Fiscal Policy
Recessions
Decrease
Aggregate
Demand
Price Level
$5 Billion
Additional
Spending
AS
Full $20 Billion
Increase in
Aggregate Demand
P1
AD1
AD2
$490
$510
Real Domestic Output, GDP
30-5
Contractionary Fiscal Policy
Reduce
Demand Pull
Inflation
$5 Billion
Initial Decrease
In Spending
Price Level
AS
Full $20 Billion
Decrease in
Aggregate Demand
P1
AD4
AD3
$510
$522
Real Domestic Output, GDP
30-6
Built-In Stability
• Automatic stabilizers
–Taxes and transfers
• Economic importance
• Tax progressivity
–Progressive tax system
–Proportional tax system
–Regressive tax system
30-7
Built-In Stability
Government Expenses, G
and Tax Revenues, T
T
Surplus
G
Deficit
GDP1 GDP2
GDP3
Real Domestic Output, GDP
30-8
Evaluating Fiscal Policy
• Standardized budget
–Full-employment budget
•
•
•
•
Cyclical deficit
Recent U.S. fiscal policy
Budget deficits and projections
Social security considerations
30-9
Government Expenses, G
and Tax Revenues, T
Evaluating Fiscal Policy
T
Cyclical deficit
Fiscal policy
neutral
$500
$450
a
b
G
c
GDP2
GDP1
(Year 2)
(Year 1)
Real Domestic Output, GDP
30-10
Government Expenses, G
and Tax Revenues, T
Evaluating Fiscal Policy
Standardized deficit
Expansionary fiscal
policy
$500
d
e
$475
$450
$425
T1
T2
G
h
f
g
GDP4
GDP3
(Year 4)
(Year 3)
Real Domestic Output, GDP
30-11
Budget Balances as % of GDP
(1)
Year
(2)
Actual
Deficit (-) or
Surplus (+)
(3)
Standardized
Deficit (-) or
Surplus (+)
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
-4.5%
-3.8%
-2.9%
-2.2%
-1.4%
-0.3%
+0.8%
+1.4%
+2.5%
+1.3%
-1.5%
-3.4%
-3.5%
-2.6%
-1.9%
-1.3%
-2.9%
-2.9%
-2.1%
-2.0%
-1.2%
-1.0%
-0.4%
+0.1%
+1.1%
+1.0%
-1.2%
-2.5%
-2.4%
-1.9%
-1.8%
-1.4%
Source: Congressional Budget Office
30-12
Standardized Budget Balance
Percentage of Potential GDP, 2007
-6
Deficits
-4
-2
0
Surpluses
2
4
6
Denmark
New Zealand
Ireland
Canada
Norway
France
United States
United Kingdom
Japan
Source: Organization for Economic Cooperation and Development
30-13
Federal Budget Balance
Actual and Projected, Fiscal 1994-2014
Actual
Projected
(as of March 2008)
Budget Deficit (-) or Surplus, Billions
$300
200
100
0
-100
-200
-300
-400
-500
1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014
Source: Congressional Budget Office
30-14
Fiscal Policy Issues
Problems, Criticisms, and Complications
• Problems of timing
–Recognition lag
–Administrative lag
•
•
•
•
•
–Operational lag
Political considerations
Future policy reversals
Offsetting state and local finance
Crowding-out effect
Current thinking on fiscal policy
30-15
The Public Debt
• National or public debt $9.01
trillion
• Ownership
–U.S. securities
–53% owned by federal government
and Federal Reserve
–47% held outside the federal
government and Federal Reserve
30-16
The Public Debt
Debt Held Outside
The Federal
Government
and Federal
Reserve (47%)
Other, Including
State and Local
Governments
U.S. Banks
And other
Financial
Institutions
8%
Debt Held by the
Federal Government
and Federal
Reserve (53%)
7%
9%
Federal
Reserve
25%
Foreign
Ownership
7%
44%
U.S.
Government
Agencies
U.S.
Individuals
Total Debt: $9.01 trillion
Source: U.S. Treasury
30-17
Debt and GDP
Federal debt held by the public, percentage of GDP
50
45
Percent of GDP
40
35
30
25
20
15
10
5
0
1970
1975
1980
1985
1990
Year
1995
2000
2005
Source: Economic Report of the President, 2006
30-18
Debt and GDP
Publicly Held Debt: International Comparisons
As a Percentage of GDP, 2007
0
20
40
60
80
100
Italy
Japan
Belgium
Hungary
Germany
United States
United Kingdom
France
Netherlands
Canada
Spain
Poland
Source: Organization for Economic Cooperation and Development
30-19
Debt and GDP
• Interest charges
–Primary burden
–1.7% of GDP 2007
• False concerns
–Bankruptcy
–Refinancing
–Taxation
–Burdening future generations
30-20
Debt and GDP
• Substantive issues
–Income distribution
–Incentives
–Foreign-owned public debt
• Crowding-out effect revisited
–Burden on future generations
–Public investment as an offset
–Graphically
30-21
Crowding Out
A Large Public Debt to Finance Public Investment Will Cause…
16
If Public Spending
Spurs More Private
Investment Will
Increase to ID2
Real Interest Rate (Percent)
14
12
b
10
c
8
a
6
Interest Rate
Rise Will
4
Decrease
2 Investment
a to b
0
5
10
CrowdingOut Effect
ID2
ID1
15
20
25
30
35
40
Investment (Billions of Dollars)
30-22
The Leading Indicators
1. Average workweek
2. Initial claims for unemployment
insurance
3. New orders for consumer goods
4. Vendor performance
5. New orders for capital goods
6. Building permits for houses
7. Stock prices
8. Money supply
9. Interest-rate spread
10. Consumer expectations
Source: The Conference Board
30-23
Key Terms
• fiscal policy
• Council of Economic
Advisers (CEA)
• expansionary fiscal
policy
• budget deficit
• contractionary fiscal
policy
• budget surplus
• built-in stabilizer
• progressive tax system
• proportional tax system
•
•
•
•
•
•
•
•
•
regressive tax system
standardized budget
cyclical deficit
political business
cycle
crowding-out effect
public debt
U.S. securities
external public debt
public investments
30-24
Next Chapter Preview…
Money and
Banking
30-25
