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Fiscal Stimulus Package
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Designed to move the economy out of recession toward full-employment GDP
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Tax Cuts and Government Spending
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Increases the size of the budget deficit
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Fiscal Stimulus
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G increases and/or transfer payments increase and/or taxes decrease, increase in the structural deficit
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Fiscal Restraint
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G decreases and/or transfer payments decrease and/or taxes increase (or increase in the structural surplus), decrease in the structural deficit (or increase in the structural surplus)
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Budget Deficit
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Amount by with G + Transfers exceed tax revenue in a given time period
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Budget Deficit Equation
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= Government Spending - Tax Revenues > 0
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Keynesian View
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Budget Deficits are a routine by-product of fiscal policy, caused by a fiscal stimulus to increase AD
The goal of macro policy is not to balance the beget but to move the economy to full-employment GDP
Keynes: Full employment first, then worry about the deficit
The goal of macro policy is not to balance the beget but to move the economy to full-employment GDP
Keynes: Full employment first, then worry about the deficit
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Discretionary Spending
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Those elements of the budget not determined by past legislative or executive commitments
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Automatic Spending
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Those elements of the budget that are a result of decisions made in prior years; said to be "uncontrollable"
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Make Up of the Budget
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Automatic (uncontrollable) 80% and Discretionary (controllable) about 20%
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Automatic Stabilizer
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Federal expenditure or revenue item that automatically responds counter cyclically to changes in national income (GDP)
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Recession Begins
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Unemployment compensation and welfare payments increase and income tax collections decrease, each stimulating economic growth in a small way
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Economic Growth Returns
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The opposite happens, which puts a small restraint on economic growth
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Cyclical Deficit
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That portion of the budget deficit attributable to short-run changes in economic conditions
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The cyclical Deficit
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Widens when GDP growth slows and shrinks when GDP growth accelerates
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As the Economy Slows
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Tax revenues decline, unemployment benefits rise, and other transfer payments rise
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As the Economy Grows
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Tax revenues rise, unemployment benefits fall, and other transfer payments fall
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Structural Deficit
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Federal revenues at full employment minus expenditures at full employment under prevailing fiscal policy
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Deficit Changes
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Part rises from cyclical changes and rest is a result of discretionary fiscal policy
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Crowding Out
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Occurs as the economy closes in on full employment.
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Economic Effects of Deficits
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Increased government borrowing to finance a growing deficit reduces the availability of funds for private sector spending so any increase in government expenditures will be offset by reductions in consumption and investment spending
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Interest Rate Movements
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An increase in demand for funds will cause the price of borrowing to rise. Rising interest rates make it more costly for consumers or businesses to borrow, and they may be cut back. Rising interest rates increase the borrowing costs of government, leaving less room in government budgets for financing new projects
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National Debt
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Accumulation of many more years of running budget deficits than budget surpluses. The U.S. Treasury bonds to lenders who want a safe investment paying out interest
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Deficit
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The national debt increases
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Surplus
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The national debt can be pared down
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The Burden of the Debt
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Refinancing, debt service, and opportunity cost
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Refinancing
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The issuance of new debt in payment of debt issued earlier. When a Treasury bond matures, new funds are borrowed to pay it off so the debt remains debt. There is no addition to the debt. Only another deficit adds to te debt.
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Debt Service
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The interest required to be paid each year on outstanding debt. Increased interest payments use up funds that cannot be used for other government expenditures. Debt servicing is a redistribution of income from taxpayers to bondholders.
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Opportunity Cost
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True burden is this. Funds spent on government expenditures can't be used for other expenditures. Resources consumed by a government expenditure can't be used to produce other goods and services. The value placed on these forgone goods and services is the opportunity cost, however financed.
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The Real Trade-Offs
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Deficit spending changes the mis of output in the direction of more public sector goods. Burden is crowding out of deficit-financed government activity.
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Repayment
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If the U.S. Treasury pays off maturing bonds with taxes, it is a redistribution of income from taxpayers to bondholders. The heirs of current bondholders receive the payout. The taxpayers in the future are hit with the taxes to pay off the maturing bonds.
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External Debt
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Borrowing from foreigners eliminates crowding out. As long as foreigners are wiling to hold U.S. debt, external financing imposes no real cost. If foreigners no longer want to hold U.S. debt, they will sell their bonds and hold dollars, which they can use to buy dollar-denominated goods and services, mainly U.S. exports. External debt will be repaid with exports of real goods and services.
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