13.4 Recent and Projected U.S. Fiscal Policy

What is fiscal policy?

Government decisions about spending and taxation to influence the economy.

What is an actual budget deficit?

The real gap between government spending and tax revenue in a given year.

What is a cyclically adjusted deficit?

The deficit corrected for the ups and downs of the business cycle — shows true policy stance.

What is a cyclical deficit?

A deficit caused automatically by a recession — lower tax revenue and higher safety net spending.

Why is the cyclically adjusted deficit usually smaller than the actual deficit?

Because it removes the automatic effects of the business cycle (like lost tax revenue during recessions).

Why do economists focus on cyclically adjusted deficits?

To judge whether fiscal policy is expansionary, contractionary, or neutral.

What was fiscal policy like from 2005–2007?

Economy reached full employment; small cyclically adjusted deficits (~−1.2%) showed mild stimulus.

What happened in 2008 during the Great Recession?

Actual deficit rose to −3.1%; adjusted deficit to −2.9% → expansionary policy via stimulus checks.

What was the 2009 fiscal response?

$787B stimulus (infrastructure, education, monthly tax rebates) → adjusted deficit −7.5%.

Why did stimulus continue after 2009?

Recovery was slow, unemployment stayed high → deficits remained large through 2015.

What was the CARES Act?

$2.2 trillion stimulus passed in March 2020 to counter COVID’s economic damage.

What was the actual deficit in 2020?

−14.9% of GDP — highest peacetime deficit ever.

What was the cyclically adjusted deficit in 2020?

−14.3% → shows most of the deficit was intentional stimulus, not just recession effects

What did the small GDP gap in early 2021 show?

Stimulus worked — economy was close to full employment again.

What happened by March 2022?

Inflation hit 8.5% → economists warned that continued stimulus might be overheating the economy.

What does expansionary fiscal policy do?

Increases government spending or cuts taxes to boost aggregate demand and GDP.

What does contractionary fiscal policy do?

Reduces spending or raises taxes to slow down inflation or cool an overheated economy.

When is stimulus risky?

During full employment — it can cause inflation if the economy doesn’t need boosting.

What does a large cyclically adjusted deficit during full employment suggest?

The government is applying strong stimulus even though the economy may not need it.

What is the formula for budget balance?

Tax Revenues − Government Spending

Positive —> Surplus
Negative —> Deficit

Why do economists focus on the cyclically adjusted deficit?

It shows whether fiscal policy is actively expansionary, contractionary, or neutral.

What does a large cyclically adjusted deficit mean?

The government is using expansionary fiscal policy to stimulate the economy.

What does a shrinking or surplus cyclically adjusted balance mean?

The government is using contractionary fiscal policy to slow the economy.

What does a stable cyclically adjusted balance mean?

Fiscal policy is neutral — not pushing the economy in either direction.

What is the actual budget deficit?

The total difference between government spending and tax revenue in a year.

• Includes both automatic effects (recession) and policy choices

• Shows how much the government overspent in reality

• Total gap between government spending and tax revenue
  

What is a cyclical deficit?

The part of the deficit caused automatically by a recession — less tax revenue, more safety net spending.

• Lower tax revenue + higher safety net spending during downturns

• Not a policy choice — just happens when GDP drops

• The part of the deficit caused automatically by the business cycle (recession)

What is a cyclically adjusted deficit?

The deficit after removing the cyclical effects — shows the government’s true policy stance.

• Policy decisions like stimulus or tax cuts

• Reveals whether fiscal policy is expansionary or contractionary

• The deficit without the cyclical part — shows what the government is choosing to do