DEFINITION of 'Fiscal Policy' Government spending policies that influence macroeconomic conditions. Through fiscal policy, regulators attempt to

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2 DEFINITION of 'Fiscal Policy' Government spending policies that influence macroeconomic conditions. Through fiscal policy, regulators attempt to improve unemployment rates, control inflation, stabilize business cycles and influence interest rates in an effort to control the economy. Fiscal policy is largely based on the ideas of British economist John Maynard Keynes ( ), who believed governments could change economic performance by adjusting tax rates and government spending. 2

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4 Expansionary increase/lower Tightening decrease/raise 4

5 Mandatory spending is legally required. In other words, Congress enacted bills which the President signed, and the government MUST spend on those programs. Interest on the debt must be paid or the government s borrowing costs will increase. Only 29% of the projected budget is discretionary meaning that the government has some degree of control over it. 5

6 Spending levels are a focus for fiscal policy makers. Is it better to have a deficit or a surplus? What happens to the budget if the government consistently runs a deficit? ( overspends ). 6

7 Transfer payments are a component of government spending. They are the largest category of spending and include grants and other payments not made in return for a product or service examples include pensions, unemployment compensation, etc. They are a form of income re distribution. products/chart gallery/detail.aspx?chartid=33360 Government transfer payments (such as medical benefits, retirement and disability insurance, and nutrition assistance programs) comprise a large share of personal income for both nonmetro and metro residents. Transfer payments to individuals accounted for 25.6 percent of total nonmetro personal income and 16.8 percent of metro personal income, in Of the $2.2 trillion in Federal, State, and local government personal transfer payments to individuals in 2010, $415 billion went to nonmetro residents and $1.8 trillion went to metro residents. The counties with the highest percentage of total income from government transfer payments in 2010 were concentrated in Appalachia and the Mississippi Delta. The top three nonmetro counties with the highest percentage of total income from government transfer payments were located in eastern coal fields of Kentucky. These counties have high levels of disability payments along with very high unemployment and poverty rates. This chart is from the Rural Poverty & Well Being topic page on the ERS website. 7

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9 Taken out of context, the numbers are staggering. The US has a total debt pile of almost $17 trillion ( 10.6 trillion), which is expected to rise to almost $23tn in the next five years. 9

10 Looking at debt to GDP tells us that total US debt is roughly equivalent to its annual economic output. It is by far the largest economy in the world, and has the largest debt pile. 10

11 Government Deficit as a percentage of GDP Much of this debt has been accumulated over the long term, but the numbers have rocketed in recent years as governments have struggled to cope with the 2008 financial crisis and the subsequent recessions that have ravaged almost all major economies. Banking bailouts, economic stimulus measures and falling tax revenues have all forced governments to borrow more. For example, in 2007, the UK's debt pile was just 44% of GDP compared with 88% last year. This reflects in part the country's large financial sector relative to its overall economy. The US's debt to GDP ratio in 2007 was 64%, the same as France and Germany. 11

12 Hitting the debt ceiling would hamstring the government's ability to finance its operations, like providing for the national defense or funding entitlements such as Medicare or Social Security. Under normal circumstances, the government is able to auction off new debt (typically in the form of U.S. Treasury securities) in order to finance annual deficits. However, the debt limit places an absolute cap on this borrowing, requiring congressional approval for any increase (or decrease) from this statutory level. debt and deficits/us debt ceiling costs consequences/p

13 Historically, the U.S. Treasury market has been driven by huge investments from surplus countries like Japan and China, which view the United States as the safest place to store their savings. A 2011 Congressional Research Service report suggests that a loss of confidence in the debt market could prompt foreign creditors to unload large portions of their holdings, thus inducing others to do so, and causing a run on the dollar in international markets. However, others claim that a sudden sell off would run counter to foreign economic interests, as far as those interests run parallel to a robust U.S. economy. debt and deficits/us debt ceiling costs consequences/p

14 Inside lag long Outside lag short Which typically puts pressure on policy makers to use Monetary policy not fiscal policy to influence the economy in the short run. (Fewer politics = less time to choose.) 14