Deficits and Debt Screen shot from 3/11/16

Transcription

1 Deficits and Debt Screen shot from 3/11/16 McGraw-Hill/Irwin Colander, Economics 1

2 Last year Screen shot from 3/21/15 McGraw-Hill/Irwin Colander, Economics 2

3 FISCAL POLICY McGraw-Hill/Irwin Colander, Economics 3

4 Fiscal Policy Fiscal policy: refers to the government's policy on taxes and government spending and how they affect the flow of income in the economy McGraw-Hill/Irwin Colander, Economics 4

5 Expansionary Fiscal Policy Expansionary fiscal policy: a fiscal policy that increases aggregate demand (AD) Can be in the form of: an increase in government spending or a decrease in taxes (or an increase in transfer payments) McGraw-Hill/Irwin Colander, Economics 5

6 Contractionary Fiscal Policy Contractionary fiscal policy: a fiscal policy that decreases aggregate demand (AD) Can be in the form of: a decrease in government spending or an increase in taxes (or a decrease in transfer payments) McGraw-Hill/Irwin Colander, Economics 6

7 Fiscal Policy and the Multiplier If the government increases spending by $50 billion dollars and MPC is 0.5, what is the impact on the economy? Multiplier=1/1-MPC Multiplier=2 $50 billion (2)=$100 billion increase in real GDP McGraw-Hill/Irwin Colander, Economics 7

8 Fiscal Policy and the Multiplier What would happen if the government decreases spending by $50 billion and MPC was 0.5? There would be a -$100 billion decrease in real GDP McGraw-Hill/Irwin Colander, Economics 8

9 What about Transfer Payments? What if the government decides to increase transfer payments? The change in real GDP is not as great because consumers will save some of the transfer payment McGraw-Hill/Irwin Colander, Economics 9

10 What about Taxes? What if the government decides to decrease taxes? Some of the tax cut will be saved and it will have less of an impact on AD/real GDP McGraw-Hill/Irwin Colander, Economics 10

11 Discretionary Fiscal Policy Discretionary fiscal policy involves actions taken by the government to correct economic instability/problems The largest discretionary spending category is national defense about 50% of the entire discretionary budget This is spending that has to be authorized by Congress each year McGraw-Hill/Irwin Colander, Economics 11

12 Nondiscretionary Spending Nondiscretionary spending is money the government is required to spend (also known as mandatory spending) and is often fixed by law It can include interest on the national debt as well as entitlement programs, such as Social Security and Medicare McGraw-Hill/Irwin Colander, Economics 12

13 DEFICIT AND DEBT McGraw-Hill/Irwin Colander, Economics 13

14 The Definition of Debt and Assets Debt is accumulated deficits minus accumulated surpluses Debt is a stock concept (defined at a point in time) Deficits and surpluses are flow concepts (defined for a period of time) 34-14

15 The Federal Deficit and Debt Budget surplus: when the government takes in more than it spends The last surplus was between Budget deficit: when the government spends more than it takes in McGraw-Hill/Irwin Colander, Economics 15

16 The Federal Deficit and Debt Both of these terms refer to one year at a time with regard to government spending Deficit spending: when a government spends more than it collects in revenue for a given year Annual deficits contribute to the national debt, the total amount of money that our nation owes McGraw-Hill/Irwin Colander, Economics 16

17 Deficits and Surpluses In the short run, if the economy is below potential, deficits are good because deficits increase expenditures moving output closer to potential Long-run surpluses are good because they provide saving for investment McGraw-Hill/Irwin Colander, Economics 17

18 Causes of Deficit There are 4 main causes of deficit spending: National emergencies, such as wartime 9/11, the War in Iraq, and Afghanistan Need for public goods and services Such as infrastructure and maintaining airports and roads McGraw-Hill/Irwin Colander, Economics 18

19 Causes of Deficit Stabilization of the economy The government may spend more money than it has taken in to stimulate the economy Government bailouts of 2008 Stimulus package of tax cuts in 2009 Role of the government in society People depend on the government for Social Security, Medicare, and Medicaid and these programs are expensive McGraw-Hill/Irwin Colander, Economics 19

20 Financing the Deficit The government finances its deficit by selling bonds to private individuals and the Fed The Fed can print an unlimited amount of money to buy bonds, but printing too much money is BAD and causes inflation 34-20

21 Financing the Deficit When the government borrows money to fund the deficit it is affecting private investment As the government crowding out borrows large amounts of money, its can increase interest rates Higher interest rates discourage individuals and businesses from borrowing money, which reduces their spending and investment activities McGraw-Hill/Irwin Colander, Economics 21

22 Financing the Deficit If the government borrows money to cover its deficit, it increases demand for loanable funds and crowds out private investment Real Interest Rate S 1 or S LF1 r 2 r 1 D 2 or D LF2 Q 1 Q 2 D 1 or D LF1 Q of Loanable Funds McGraw-Hill/Irwin Colander, Economics 22

23 Structural and Passive Deficits Many government revenues and expenditures depend on the level of income in the economy Structural deficit: the part of the budget deficit that would exist even if the economy were at its potential income Passive deficit: the part of the deficit that exists because the economy is operating below its potential level of output 34-23

24 Structural and Passive Deficits There is disagreement about what percentage of a deficit is structural and what percentage is passive Actual deficit = structural deficit + passive deficit Passive deficit = tax rate x (potential output actual output) Structural deficit = actual deficit passive deficit 34-24

25 Nominal and Real Surpluses and Deficits Nominal deficit: the difference between expenditures and receipts The value that is reported Real deficit: is the nominal deficit adjusted for inflation Inflation wipes out debt in the sense that if there is 4% inflation, the debt is declining by 4% 34-25

26 Nominal and Real Surpluses and Deficits Real deficit = Nominal deficit (Inflation x Total debt) Lowering the real deficit by inflation can be costly Persistent inflation becomes built into expectations and causes higher interest rates McGraw-Hill/Irwin Colander, Economics 26

27 Raising Money for Deficit Spending The U.S. Treasury must sell new bonds to pay for a deficit and refinance previously issued bonds as they come due Treasury bills (T bills) are short-term bonds that mature in less than one year Treasury notes are bonds that mature between two and ten years Some Treasury bonds are issued for 30 years McGraw-Hill/Irwin Colander, Economics 27

28 What are Treasury Bills, Notes, and Bonds? Treasury bills, notes, and bonds are sold by the U.S. Treasury Department These are the safest investments in the world, since they are backed by the U.S. Government Since they are so safe, they tend to have the lowest interest rates McGraw-Hill/Irwin Colander, Economics 28

29 What are Treasury Bills, Notes, and Bonds? Treasury bills, notes, and bonds are sold at auction This means they can be bought for more or less than the face value, depending on demand For example, when demand is high, bidders will pay more than face value nds.htm McGraw-Hill/Irwin Colander, Economics 29

30 How Do Treasury Bills, Notes, and Bonds Affect the Economy? Treasury bills, notes and bonds are simply called Treasuries for short They affect the economy in two important ways: First, they fund the U.S. debt The Treasury Department issues enough bills, notes, and bonds to pay ongoing expenses that aren't covered by incoming tax revenue If the U.S. defaulted on its debt, these expenses would not be paid McGraw-Hill/Irwin Colander, Economics 30

31 How Do Treasury Bills, Notes, and Bonds Affect the Economy? This means military and government employees wouldn't receive their salaries or benefits, and recipients of Social Security, Medicare, and Medicaid would not receive benefits McGraw-Hill/Irwin Colander, Economics 31

32 Impact of Inflation on Treasury Bonds What role does inflation play? An important one if you are holding bonds or Treasury notes Remember, these are fixed price assets and only give a fixed interest each year As inflation spirals faster than the return on these assets, they become less valuable As they become less valuable, people rush to sell them, further depreciating their value McGraw-Hill/Irwin Colander, Economics 32

33 Ownership of the Debt The U.S. debt is more than $19.1 trillion See About two-thirds of this is the public debt, which is owed to the people, businesses and foreign governments who bought Treasury bills, notes, and bonds McGraw-Hill/Irwin Colander, Economics 33

34 Ownership of the Debt China owns about $1.3 trillion of our debt It keeps its currency the yuan weaker than the U.S. dollar to keep Chinese goods competitive Remember though if China started selling a chunk of its U.S. debt the value of the dollar would be heavily impacted as would interest rates McGraw-Hill/Irwin Colander, Economics 34

35 Debt Ceiling The debt ceiling is the legal limit set by Congress on the total amount that the U.S. Treasury can borrow If the level of federal debt hits the debt ceiling, the government cannot legally borrow additional funds until Congress raises the debt ceiling McGraw-Hill/Irwin Colander, Economics 35

36 Difference Between Individual and Government Debt Deficits and Debt Government debt is ongoing and never has to pay back its debt 2. The government can print money to pay its debt 3. Government owes much of its debt to itself (to its own citizens) 34-36

37 Internal & External Debt Internal debt: government debt owed to other governmental agencies or to its own citizens External debt: government debt owed to individuals in foreign countries McGraw-Hill/Irwin Colander, Economics 37

38 Chapter Summary A deficit is a shortfall of revenues under payments A surplus is an excess of revenues over payments Debt is accumulated deficits minus accumulated surpluses Deficits and surpluses are summary measures of a budget Budget deficits and surpluses should be judged in light of economic and political conditions Whether a budget deficit is a problem depends on the budgeting procedures that measure it 34-38

39 Chapter Summary A passive deficit is the part of the deficit that exists because the economy is below its potential A structural deficit is that part of a budget deficit that would exist even if the economy were at its potential income Structural deficit = Actual deficit Passive deficit A real deficit is a nominal deficit adjusted for inflation Real deficit = Nominal deficit (InflationxDebt) A country s debt must be judged in relation to its assets 34-39

40 Chapter Summary What is counted as a debt and as an asset can be arbitrary Government debt and individual debt differ in three major ways: Government is ongoing and never needs to repay its debt Government can pay off its debt by printing money Most of the government debt is internal owed to its own citizens so interest payments go to U.S. citizens 34-40

41 Chapter Summary Deficits, surpluses, and debt should be viewed relative to GDP because this ratio better measures the government s ability to handle the deficit and pay off the debt The Economic Growth and Tax Relief Reconciliation Act of 2001, an economic slowdown, and the war on terrorism contributed to a return to budget deficits in