Lesson 6.4: Deficits and Debt in Fiscal Policy

Flashcards made from a presentation segment created as a lesson on deficits and debt in fiscal policy.

Classical economics

School of thought based on the idea that free markets regulate themselves

• Believes that struggling economies can recover on their own

  • Does not account for the time needed to return to equilibrium

• Challenged by the Great Depression with inadequate self-regulation, high unemployment, and immense bank failures

Keynesian economics

School of thought that uses demand-side theory as the basis for encouraging governmental action to help the economy

• Developed by John Maynard Keynes, focusing on the economy as a whole with governmental responsibility to boost demand

• Drastically changed the role of government in the United States’ free enterprise system, used to fight periods of recession and inflation for full productive economic capacity

John Maynard Keynes

British economist that developed Keynesian economics, promoting more governmental intervention

Multiplier effect

A concept in Keynesian economics that refers to the idea that every one-dollar change in fiscal policy creates a change greater than one dollar in the national income, multiplying the effects of changes in fiscal policy

Spending multiplier

Aspect of the mutiplier effect that demonstrates how governmental purchases of goods and services boost GDP both directly and indirectly

• Seen through defense spending with contractors spending money that flows throughout the economy

Supply-side economics

School of thought based on the idea that the supply of goods drives the economy

• Taxes thus have a strong negative effect on economic output

Laffer Curve

A graph that illustrates the effects of taxes on revenue, demonstrating how a moderate optimal tax rate can produce more revenue than a lower or higher tax

Budget gap

Occurs when the government spends more or less than it earns in the budget

Budget surplus

Occurs in any year when revenues exceed expenditures, with more money going into the Treasury than coming out of it

Budget deficit

Occurs in any year when expenses exceed expenditures, with more money coming out of the Treasury than going into it

• Often a common characteristic of the economy in recent decades

• Can be dealt with through money creation for small amounts and debt through bonds for larger amounts

Savings bond

A bond that allows people to loan the government small amounts of money, and in return, they earn interest on the bonds for up to 30 years

Treasury bills

Short-term bonds that have maturity dates of 26 weeks or less

Treasury notes

Bonds that have maturity dates of 2 to 10 years

Treasury bonds

Bonds that have maturity dates of 30 years after issue

National debt

The total amount of money the federal government owes to bondholders

• Increases every year there is a budget deficit and the federal government borrows money to cover it

• Best viewed as a percentage of GDP over time due to the large amount

• Concerns have been raised over the goverment’s large interest payments and foreign involvement

National deficit

The amount of money the government borrows for one fiscal year

Crowding-out effect

Occurs with a higher national debt and reduced funds available for businesses as funds are used to pay for interest

• Crowds out private firms that would have borrowed these funds for investment spending, potentially reducing economic growth

Gramm-Rudman-Hollings Act (1985)

An act that created automatic across-the-board cuts in expenditures if the deficit exceeded a certain amount

• While it did exempt many programs, the Supreme Court ruled that some parts of the Act were unconstitutional

• Further revisions led to a shifted focus towards spending control, not significantly reducing the national debt