Ch.30 Fiscal Policy, Deficits, and Debt

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Fiscal

BLANK policy consists of deliberate changes in government spending, taxes, or some combination of both to promote full employment, price-level stability, and economic growth. This requires increases in government spending, decreases in taxes, or both—a budget deficit—to increase aggregate demand and push an economy from a recession. Decreases in government spending, increases in taxes, or both—a budget surplus—are appropriate for decreasing aggregate demand to try to slow or halt demand-pull inflation.

tax

Built-in stability arises from net BLANK revenues, which vary directly with the level of GDP. During recession, the Federal budget automatically moves toward a stabilizing deficit; during expansion, the budget automatically moves toward an anti-inflationary surplus. Built-in stability lessens, but does not fully correct, undesired changes in real GDP.

cyclical

Actual Federal budget deficits can go up or down because of changes in GDP, changes in fiscal policy, or both. Deficits caused by changes in GDP are called BLANK deficits. The cyclically adjusted budget removes cyclical deficits from the budget and therefore measures the budget deficit or surplus that would occur if the economy operated at its full-employment output throughout the year. Changes in the cyclical-budget deficit or surplus provide meaningful information as to whether the government's fiscal policy is expansionary, neutral, or contractionary. Changes in the actual budget deficit or surplus do not, since such deficits or surpluses can include cyclical deficits or surpluses.

2007

In 2001 the Bush administration and Congress chose to reduce marginal tax rates and phase out the Federal estate tax. A recession occurred in 2001, and Federal spending for the war on terrorism rocketed. The Federal budget swung from a surplus of $128 billion in 2001 to a deficit of $158 billion in 2002. In 2003 the Bush administration and Congress accelerated the tax reductions scheduled under the 2001 tax law and cut tax rates on capital gains and dividends. The purposes were to stimulate a sluggish economy. By BLANK the economy had reached its full employment level of output.

cyclically

The Federal government responded to the deep recession of 2007-2009 by implementing highly expansionary fiscal policy. In 2008 the Federal government passed a tax rebate program that sent $600 dollar checks to qualified individuals. Later that year, it created a $700 billion emergency fund to keep key financial institutions from failing. These and other programs increased the BLANK adjusted budget deficit from −1.2 percent of potential GDP in 2007 to −2.8 percent in 2008. When the economy continued to plunge, the Obama administration and Congress enacted a massive $787 billion stimulus program to be implemented over 2½ years. The cyclically adjusted budget deficit shot up from −2.8 percent of potential GDP in 2008 to −7.3 percent in 2009.

timing, political, households, crowding

Certain problems complicate the enactment and implementation of fiscal policy. They include (a) BLANKING problems associated with recognition, administrative, and operational lags; (b) the potential for misuse of fiscal policy for BLANKAL rather than economic purposes; (c) the fact that state and local finances tend to be pro-cyclical; (d) potential ineffectiveness if BLANKS expect future policy reversals; and (e) the possibility of fiscal policy BLANKING out private investment.

fiscal

Most economists believe that BLANK policy can help move the economy in a desired direction but cannot reliably be used to fine-tune the economy to a position of price stability and full employment. Nevertheless, this policy is a valuable backup tool for aiding monetary policy in fighting significant recession or inflation.

public

The BLANK debt is the total accumulation of all past Federal government deficits and surpluses and consists of Treasury bills, Treasury notes, Treasury bonds, and U.S. savings bonds. In 2009 the U.S. public debt was $11.9 trillion, or $37,437 per person. The public (which here includes banks and state and local governments) holds 57 percent of that Federal debt; the Federal Reserve and Federal agencies hold the other 43 percent. Foreigners hold 29 percent of the Federal debt. Interest payments as a percentage of GDP were about 1.3 percent in 2009. This is down from 3.2 percent in 1990.

refinanced, taxes

The concern that a large public debt may bankrupt the U.S. government is generally a false worry because (a) the debt needs only to be BLANKED rather than refunded and (b) the Federal government has the power to increase BLANKS to make interest payments on the debt.

generations, securities

In general, the public debt is not a vehicle for shifting economic burdens to future BLANKS. Americans inherit not only most of the public debt (a liability) but also most of the U.S. BLANKS (an asset) that finance the debt.

inequality, taxes, output, crowd

More substantive problems associated with public debt include the following: (a) Payment of interest on the debt may increase income BLANK. (b) Interest payments on the debt require higher BLANKS, which may impair incentives. (c) Paying interest or principal on the portion of the debt held by foreigners means a transfer of real BLANK abroad. (d) Government borrowing to refinance or pay interest on the debt may increase interest rates and BLANK out private investment spending, leaving future generations with a smaller stock of capital than they would have had otherwise.

investment, complements

The increase in BLANK in public capital that may result from debt financing may partly or wholly offset the crowding-out effect of the public debt on private investment. Also, the added public investment may stimulate private investment, where the two are BLANKS.

fiscal policy

Changes in government spending and tax collections designed to achieve a full-employment and noninflationary domestic output; also called discretionary fiscal policy.

Council of Economic Advisers (CEA)

A group of three persons that advises and assists the president of the United States on economic matters (including the preparation of the annual Economic Report of the President).

expansionary fiscal policy

An increase in government purchases of goods and services, a decrease in net taxes, or some combination of the two for the purpose of increasing aggregate demand and expanding real output.

budget deficit

The amount by which the expenditures of the Federal government exceed its revenues in any year.

contractionary fiscal policy

A decrease in government purchases of goods and services, an increase in net taxes, or some combination of the two, for the purpose of decreasing aggregate demand and thus controlling inflation.

budget surplus

The amount by which the revenues of the Federal government exceed its expenditures in any year.

built-in stabilizer

A mechanism that increases government's budget deficit (or reduces its surplus) during a recession and increases government's budget surplus (or reduces its deficit) during an expansion without any action by policymakers. The tax system is one such mechanism.

progressive tax system

A tax whose average tax rate increases as the taxpayer's income increases and decreases as the taxpayer's income decreases.

proportional tax system

A tax whose average tax rate remains constant as the taxpayer's income increases or decreases.

regressive tax system

A tax whose average tax rate decreases as the taxpayer's income increases and increases as the taxpayer's income decreases.

cyclically adjusted budget

A comparison of the government expenditures and tax collections that would occur if the economy operated at full employment throughout the year; the full-employment budget.

cyclical deficit

A Federal budget deficit that is caused by a recession and the consequent decline in tax revenues.

political business cycle

Fluctuations in the economy caused by the alleged tendency of Congress to destabilize the economy by reducing taxes and increasing government expenditures before elections and to raise taxes and lower expenditures after elections.

crowding-out effect

A rise in interest rates and a resulting decrease in planned investment caused by the Federal government's increased borrowing to finance budget deficits and refinance debt.

public debt

The total amount owed by the Federal government to the owners of government securities; equal to the sum of past government budget deficits less government budget surpluses.

U.S. securities

U.S. Treasury bills, notes, and bonds used to finance budget deficits; the components of the public debt.

external public debt

The portion of the public debt owed to foreign citizens, firms, and institutions.

public investments

Government expenditures on public capital (such as roads, highways, bridges, mass-transit systems, and electric power facilities) and on human capital (such as education, training, and health).

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