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CH 31+32: Deficit and DebtLECTURE
Screenshot from 2/20/20
2020
Screenshot from 2/21/19
2019
4Screenshot from 3/3/18
2018
2017
5Screenshot from 3/9/17
Screenshot from 3/11/16
2016
2015
Screenshot from 3/21/15
Fiscal Policy
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
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)
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)
Discretionary Fiscal Policy
• Discretionary fiscal policy involves actions taken by the government to correct economic instability/problems
• This is spending that has to be authorized by Congress each year
• Estimated at $1.485 trillion for 2021 fiscal year
• The largest discretionary spending category is national defense which is more than 50% of the discretionary budget
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
• Estimated at $2.966 trillion for 2021 fiscal year
• Social Security is the biggest expense ($1.151 trillion estimated for 2021 fiscal year)
Deficit and Debt
The Federal Deficit and Debt
• Budget surplus: when annual government spending and transfer payments are less than tax revenue
• The last surplus was between 1998-2001
• Budget deficit: when annual government spending and transfer payments are greater than tax revenue
• If the government increases spending without increasing taxes they will increases the annual deficit and the national debt
The Federal Deficit and Debt
• 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
• A government must pay interest on its accumulated debt, thus increasing the national debt
•As a result, they forgo using these funds for other uses
Financing the Deficit• When the government borrows money to fund the deficit it is
affecting private investment
• As the government borrows large amounts of money, its can increase interest rates, resulting in crowding out
• Higher interest rates discourage individuals and businesses from borrowing money, which reduces their spending and investmentactivities• Private investment is crowded out by expansionary fiscal policy• Leads to a decrease in interest-sensitive private sector
spending• In the long run this can lead to a decrease in economic growth
Financing the Deficit• Think back to the loanable funds market: If the government borrows money
to cover its deficit, it increases demand for loanable funds and crowds out private investment as the real interest rate increases
Real Interest Rate
Q of Loanable FundsQ1
S1 or SLF1
r2
D1 or DLF1
r1
Q2
D2 or DLF2
Raising Money for Deficit Spending
• The government finances its deficit by selling bonds to private individuals and the Fed
• 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
Raising Money for Deficit Spending
• To get people to buy/hold bonds, they need to be attractive
• This means higher interest rates
•This pushes up interest rates making it more expensive for businesses to borrow and in turn, reduces their investment
Ownership of the Debt
• The U.S. debt is more than $23 trillion
• See http://www.usdebtclock.org/
• About 75% of the debt is held by the public
• The government owes this to buyers of U.S. Treasury bills, notes, and bonds
• The other 25% is owed to various government departments such as Social Security
Automatic Stabilizers
• An automatic stabilizer is a built-in fiscal policy that work counter cyclically to stabilize the economy
• It supports the economy during recessions and help prevent the economy from becoming overheated during expansionary periods
• For example, tax revenues increase as GDP rises, which slows consumption and prevents the economy from overheating
• When GDP decreases, government spending increases and taxes fall
• Examples: welfare, unemployment insurance, and income taxes