5.4-5.5 Gov Spending and National Debt, Crowding Out

National Debt

total amount owed or the accumulation of budget deficits minus surpluses

Budget Deficit

when annual gov spending is GREATER than tax revenue

Expenses, Outlays > Income, Taxes

US Gov is here most of

Budget Surplus

when annual government spending is LESS than tax revenue

Income, Taxes > Expenses, Outlays

Balanced Budget

income = expenses

if Gov increases spending WITHOUT increasing taxes…

gov will increase annual deficit and national debt

Budget

A statement or plan of a gov’s receipts and expenses needed to effectively function

e.g. Federal, state, local, personal

Government Budget Balance

the difference between tax revenue and government spending

• Gov revenue and expenses

can be in one of three states:

1. Balanced Budget

2. Budget Surplus

3. Budget Deficit

Gov Revenue

receipts or income

mostly thru taxes

Gov Expenses

outlays

gov spending and transfers

Adding to Natl Debt: Fiscal Policy

1. Expansionary Fiscal - tends to lead to deficits → lower taxes and less gov sp

2. Contractionary Fiscal - tends to lead to surpluses → higher taxes and less gov sp

Over time, continuous deficit spending creates national debt (currently >$35 tril)

Financing Gov Deficit Spending

• Expansionary fiscal policy creates deficit spending → gov need to pay back debt + interest

• Effects of Deficit Spending:

  1. Increase Demand for Loanable Funds

  2. Real interest rate increases (crowding out)

Crowding Out

the adverse effect of gov borrowing on interest-sensitive private sector spending

(see notes for graph)

• Private investors’ demand remains at the original demand curve!

• However, they have to get loans at the new, higher real interest rate

• Quantity of loans demanded from private investors decreases

Long Run effect of crowding out

AD ← bc less private investment = LESS CAPITAL STOCK!!!