Fiscal Policy and theAD-AS Model

Real Domestic Output, GDP

Pri

ce L

evel

AD2

RecessionsDecreaseAggregateDemand

AD1

$5 Billion AdditionalSpending

Full $20 Billion Increase in

Aggregate Demand

AS

$490 $510

P1

Expansionary Fiscal Policy

Fiscal Policy and theAD-AS Model

Real Domestic Output, GDP

Pri

ce L

evel

AD3

RecessionsDecreaseAggregateDemand

AD4

$5 Billion Initial Decrease

In Spending

Full $20 Billion Decrease in

Aggregate Demand

AS

$510 $522

P1

Contractionary Fiscal Policy

Pop Quiz

1. To fight a recession, the government should ______ taxes and _____ government spending.

2. This expansionary policy could create a budget _________ and may __________interest rates as the government has to borrow more. This is known as the _______________________.

3. Everybody knows that if interest rates go up this will __________ foreign financial investment in the U.S. causing the dollar to _______________ in foreign exchange markets and causing net exports to go __________

lower

Increase

Deficit Increase

Crowding out effect

increase

Appreciate

Down!

Pop Quiz

1. To fight a recession, the government should ______ taxes and _____ government spending.

2. This expansionary policy could create a budget _________ and may __________interest rates as the government has to borrow more. This is known as the _______________________.

3. Everybody knows that if interest rates go up this will __________ foreign financial investment in the U.S. causing the dollar to _______________ in foreign exchange markets and causing net exports to go __________

lower

Increase

Deficit Increase

Crowding out effect

increase

Appreciate

Down!

Pop Quiz

1. To fight a recession, the government should ______ taxes and _____ government spending.

2. This expansionary policy could create a budget _________ and may __________interest rates as the government has to borrow more. This is known as the _______________________.

3. Everybody knows that if interest rates go up this will __________ foreign financial investment in the U.S. causing the dollar to _______________ in foreign exchange markets and causing net exports to go __________

lower

Increase

Deficit Increase

Crowding out effect

increase

Appreciate

Down!

Pop Quiz

1. To fight inflation, the government should ______ taxes and _____ government spending.

2. This contractionary policy could create a budget _________ and may __________interest rates as the demand for borrowed funds goes __________.

3. Everybody knows that if interest rates go down this will __________ foreign financial investment in the U.S. causing the dollar to _______________ in foreign exchange markets and causing net exports to go __________

4. This net export effect (compliments/offsets) the contractionary effort. _____________

increase

decrease

surplus decrease

decreasedepreciate

Up.

down

offsets

“Ten Things To Know About The Federal Budget”

1. The 2009 federal budget will start on ______________ and end on ________________.

2. What do economists like to compare a budget deficit to when determining its relative size?

3. Has federal spending grown in the last 50 years?

Oct. 1, 2008

September 30, 2009

The deficit as a percentage of GDP

Nominally yes, but is still between 18-20% of total spending

4. According to the reading, what percent of federal spending goes to defense? How much of our GDP does that represent?

5. What trade-off is involved in the growing size of entitlement programs?

6. What, if anything, is disturbing about financing some of our debt with our buddies in China and Japan?

20% or 4 % of our GDP

Less discretionary spending

Factor income leaving the country/transfers economic resources abroad

DEFICITS, SURPLUSES, AND DEBT

Definitions:•Budget Deficit•Budget Surplus•National or Public Debt•U.S. Securities

Causes:• Wars• Recessions• Tax Cuts

THE PUBLIC DEBTFacts and Figures:

Quantitative Aspects• Debt and GDP• International Comparisons• Interest Charges• Ownership

0 20 40 60 80 100 120 140

ItalyJapan

BelgiumCanada

SpainFrance

GermanyUnited States

NetherlandsFinlandSweden

DenmarkUnited Kingdom

Australia

GLOBAL PERSPECTIVEPublic Sector Debt as a percent of GDP,2000

Source: Organization for Economic Cooperation and Development

Social Security Considerations• Social Security Trust Fund

THE PUBLIC DEBT

False Concerns• Bankruptcy

• Refinancing• Taxation

• Burdening Future Generations

OWNERSHIP OF THE PUBLIC DEBT

9%

28%

11%

22%

13%17%

Debt heldBy FederalReserve &

GovernmentAgencies

Debt heldOutside the

FederalReserve &

GovernmentAgencies

Federal Reserve

U.S.Government

Agencies

Other, IncludingState & Local Governments

U.S. Banks & FinancialInstitutions

ForeignOwnership

U.S. Individuals

ID1

Investment (billions of dollars)

Re

al i

nte

res

t ra

te (

pe

rcen

t)

THE CROWDING OUT EFFECTWith a Deficit,An Increase in

InvestmentDemand Causes…

16

14

12

10

8

6

4

2

05 10 15 20 25 30 35 40

ID2Crowding

OutEffect

DEFICITS AND SURPLUSES1990 - 2010

Source: Economic Report of the President, 2001

$800

700

600

500

400

300

200

100

0

-100

-200

-300

Bu

dge

t D

efic

its

or S

urp

luse

s, B

illi

ons

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

ActualProjected (as of 2001)

Federal Budget Deficits and Surpluses Actual and Projected, Fiscal 1992-2012

Source: Congressional Budget Office

$300

200

100

0

-100

-200

-300

-400

-500

Bu

dg

et D

efic

it (

-) o

r S

urp

lus,

Bill

ion

s

1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

Actual Projected (as of March 2006)

Social Security Trust Fund(social insecurity )

• Many claim Social Security may go bankrupt soon due to

• BABY BOOM Retirement

1st Boomer Retires

Ways to save Social Security

Ways to save social security

1. Delay Retirement Age

2. Means Test Only give it to those

who need it

3. Raise the social security tax

currently 6.2%

4. Increase maximum amount of income that can be taxed (cap)…currently the income max is $97,500

5. Reduce Benefits

6. Privatize Accounts

Built-In Stability

G

T

Deficit

Surplus

GDP1 GDP2 GDP3

Real Domestic Output, GDP

Go

vern

men

t E

xpen

ses,

Gan

d T

ax R

even

ues

, T

Standardized Budget versus the Actual Budget

• The Standardized Budget…• measures the Federal budget deficit or surplus that

would occur if the economy operated at full employment throughout the year. (full employment budget)

• Cyclical deficits or surpluses are those that result from changes in GDP. (actual deficits/surpluses that occur automatically)

• Changes in the standardized deficit or surplus indicate whether the government is engaging in expansionary or contractionary fiscal policy.

• Changes in the actual budget deficit or surplus do not since the deficits or surpluses can include cyclical deficits or surpluses

(1)Year

(2)Actual

Deficit (-) orSurplus (+)

(3)StandardizedDeficit (-) orSurplus (+)

Recent U.S. Fiscal Policy

1990199119921993199419951996199719981999200020012002200320042005

-3.9%-4.4%-4.5%-3.8%-2.9%-2.2%-1.4%-0.3%+0.8%+1.4%+2.5%+1.3%-1.5%-3.4%-3.5%-2.6%

-2.2%-2.5%-2.9%-2.9%-2.1%-2.0%-1.2%-1.0%-0.4%+0.1%+1.1%+1.1%-1.1%-2.7%-2.4%-1.8%

Federal Deficits and Surpluses – 1990 - 2005 as a Percentage of Potential GDP

Source: Congressional Budget Office

Expansionary