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Chapter 13. Fiscal Policy Link to syllabus Plus page 538 - Supply Side Economics and the Laffer Curve.

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Government Spending and Taxes/GDP. Fig 13-1 p. 378

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Breakdown of US Government Taxes and Spending, 2007. Figs. 13-2 and 13-3, p. 379 (Seems to be total govt)

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Michigan Taxes & Spending Michigan Taxes

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Figure 13-6. p. 384 The 2009 Recovery Act. (billion $) Financial bailouts are not included here.

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Hypothetical Effect of Fiscal Policy. Tab. 13-1 p. 386 MPC is 0.5. Minor detail: the right hand column is less than the middle column, because people dont spend the total amount of the transfer. Nevertheless, the multiplier is always positive.

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The US Federal Budget Deficit and the Business Cycle. Figure 13-7, p. 391 The (absolute and relative) size of the deficit increases during recessions, and falls during expansions. This is only partially due to countercyclical spending.

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The US Federal Budget Deficit and Unemployment. Figure 13-8, p. 391.

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The Actual Budget Deficit versus the Cyclically Adjusted Budget Deficit. Fig. 13-9, 392

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Recall: Fig. 10-5 p. 286. An Increase in the Demand for Loanable Funds. Standard example; increased government deficit, financed internally Govt Spending Interest Rates Business Investment Crowding out reduces or eliminates Positive AD effect of govt spending

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U.S. Federal Deficits and Debt/GDP. Fig. 13-11 p. 398 x

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US Debt/GDP source: Statistical Abstract of US

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Data on US Government Debt 2002 2011 Total $(trillion) 6.4 14.8 Privately held 3.0 8.4 Held by Foreigners 1.2 4.7 Foreign/Total (%) 19 32 Foreign/Private 41 55 Source: Calculations based on data from US Treasury

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Japanese Deficits and Debt/GDP. Fig. 13-12 p. 371

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Global Comparison p. 396. Debt Levels Other countries like Norway: UAE, Saudi Arabia, Kuwait

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Future Demands on the Federal Deficit. Fig. 13-12, p. 400 mt believes it is irresponsible to include 80 year projections, because so much can and will change.

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US deficits, 1930-2010 Data from U.S. CBO x

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Review of Deficit/Debt, by Presidents For a long time, balanced budget was the goal. This was changed by Roosevelt, and re-enforced by Kennedy/Johnson The deficit grew dramatically under Reagan. This was caused by his tax cuts, increased defense spending, and the contractionary policies of the Federal Reserve Bank. Under Clinton, the deficit was turned into a surplus. Perhaps this was due to good policies. Republicans would claim that it was due to their not letting him spend in areas like Health Care. A major contributor to the non-re-election of George H Bush was his promise of No new taxes, which he broke.

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Deficit under George W. Bush When W. was elected, all projections were for surpluses as far as the eye can see. As a candidate, W. promised tax cuts, and implemented one quickly after entering office, mailing tax refunds to citizens. The crisis of 2008 dramatically worsened the deficit. The majority of economists would probably agree that the overall impact of W.s tax cuts was regressive, i.e. lowering taxes more for the very wealthy. The Obama administration is currently in debates with Republicans about extending or reversing those taxes.

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Why did the Clintons government surplus turn into deficit under President Bush? 1.Economic slowdown (39%) 9-11 Bubble economyEnron, World.com, Increasing competition from overseas producers 2. Tax cuts (27%) 3. Greater spending on Iraq, Homeland security (19%) 4. Others (15%) Analysis according to Henry Aaron (Brookings Inst.) Source: http://www.brookings.edu/dybdocroot/views/testimony/aaron/20040204.pdfhttp://www.brookings.edu/dybdocroot/views/testi

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The Deficit under Obama Near the end of the President Bushs term, it became clear that massive steps were needed to avoid a financial meltdown, and the Bush/Paulson requests for these were approved by Congress. These actions involved expansionary spending and transfers, and bailing out banks and auto companies. These programs were continued under President Obama, with Fed Chief Bernanke and Treasury Secretary Geithner providing continuity. It is inevitably the case that some of those actions were not taken with sufficient care and forethought. It is also the case that Obama did not get as much as he wanted from Congress.

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Current Issues It is very difficult to predict what will happen to the deficit: a. Tax revenues decline in a recession are we in a double dip recession? b. Some of the massive increase of the deficit was caused by the massive bailouts. This was one-time-only spending, so the deficit will be reduced if there are no new bailouts. c. The actual dollar amounts of those recent major bail-outs will not be known for a while, until all the accounting is in, and we know what value the government receives for re-selling the companies. d.The 2010 election saw the rise to power of anti-deficit [tea-party] hawks, who want to stop the bail-outs and other expansionary (but deficit-creating) programs, and lower some taxes. e.With Obamas re-election, his policies wont change. Mitt Romney offered the prospect of a replay of the experience with Reagans supply side policy of aggressive tax cuts.

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White House and CBOs Deficit Projections, 2009 Source: Washington Post March 21, 2009

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Gramm Rudman Hollings Act, 1985 (and revisions) Set up a multi-year schedule of targets for reduction of govt deficits. If the deficit didnt meet the targets, there would be automatic cuts - sequesters - and these automatic cuts would not touch defense nor Social Security. Was declared unconstitutional by the Supreme Court, as it gave somebody (the computer programmer for the Congressional Budget Office) power over both the Legislative and the Executive branches. Also, Congress ignored rules during wars and emergencies. Importance: Seemed to be the last chance at achieving this by legislation, short of a constitutional amendment. Rudman to Congress: Im filing for divorce on the grounds of infidelity and irreconcilable differences.

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Unless the fractious U.S. Congress can strike a deal, about $600 billion in U.S. spending cuts and higher taxes are due to kick in on January 1, threatening to push the U.S. economy back into recession and hurt world growth. Not only are tax cuts enacted under President George W. Bush set to expire, but automatic spending cuts designed to exert pressure on lawmakers to strike a long-term budget deal will also take effect. The U.S. Congress will also soon face the need to raise the nation's debt limit to avoid a default. The reason the fiscal cliff is such a threat to 2013s economy isnt that its too little deficit reduction its that its too much all at once, 5.1 percent of GDP in a single year, which could throw the economy into recession. Republicans agree on that. Democrats agree on that. And in agreeing on that, both sides appear to be embracing an argument thats been rather contentious in recent years: that fiscal stimulus boosts short- term economic growth and budget cuts hurt it.5.1 percent

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Deficit/Debt Debates: Scattered parts of Chapter 17 False arguments: We have to pay it back (think a large corporation) Federal government deficits cause inflation or unemployment Potentially valid arguments against: Government deficits cause crowding out, lowering business investment. We used to say we owe it to ourselves, but this is becoming less true. Confusing aspects: What measure of the debt to use all, or just that owned by the public? What about social security, which is a commitment, but not a debt? What about off-budget spending?

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(Different Textbook). The Laffer Curve, mentioned (without graph) on p. 538 of Krugman/Wells. When the graph is not in our textbook, its not on the exam. Laffer range Traditional range

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Were Reagans tax cuts a fair test of the Laffer Curve? Early in his term President Reagan cut taxes, and the deficit grew. Many economists not just Keynesians believe this disproves Laffer. However: 1) Although Reagan cut taxes to consumers, Congress did not approve cuts in business taxes [Trickle Down Economics] 2) The Federal Reserve, under Paul Volcker, applied contractionary monetary policy, which presumably overwhelmed the tax cuts, because the economy went into a recession. 3) Reagan also increased defense spending. Note that K/W are rather dismissive of the Laffer radical supply side story

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(other text). Federal budget surpluses and deficits 1992-2012

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Source: New York Times, Feb. 27, 2009