ap economics: module 30 terms

expansionary fiscal policy

increases aggregate demand

• increase G, decrease T, increase TR

• used in recessionary gaps

• decreases the budget balance (makes surpluses smaller and deficits larger)

contractionary fiscal policy

decreases aggregate demand

• decrease G, increase T, decrease TR

• used in inflationary gaps

• increase the budget balance (make surpluses bigger and deficits smaller)

t or f: budget deficits are always a bad thing

f: can actually be fine as long as real GDP is growing at a significantly higher rate + even though govt. is in a deficit, their extra spending may be going towards public welfare

budget balance

difference between a government’s tax revenue (T) and spending (G and TR)

• T - G - TR

• + → surplus (expansion), - → deficit (recession)

2 reasons that using changes in the budget balance to see if current fiscal policy is exp. or cont. is misleading

1. 2 changes in fiscal policy may have equal effects on the budget balance, but different effects on the economy

   a. think about spending vs. tax/transfer multiplier

2. changes in the budget balance are usually the result, not the cause of economic fluctuations

relationship between the budget deficit and unemployment

positive

how is the relationship between the budget deficit and unemployment driven by automatic stabilizers?

economy expands → taxes increase, transfers (unemployment insurance) decrease

• opposite when economy contracts

change in budget balance from business cycle vs. change in budget balance from discretionary fiscal policy

business cycle:

• affected by automatic stabilizers

• temporary effects (recessionary/inflationary gaps not in long run)

discretionary fiscal policy:

• affected by changes in G, T, and TR

cyclically adjusted budget balance

an estimate of what the budget balance would be if RGDP was exactly equal to potential output

• no r gap/i gap

• considers…

  • extra T and saved TR if R gap was eliminated

  • lost T and extra TR if I gap was eliminated

why may politicians still want to run perisistent budget deficits despite their harm to the government and economy?

in a deficit…

• they can decrease taxes w/o decreasing spending

• they can increase spending w/o increasing taxes

*legislation passed to ensure this doesn’t happen → annual balanced budget

why do some economists believe the budget shouldn’t be balanced?

• undermines the role of T and TR as automatic stabilizers → may worsen economic fluctuations

• limits the government's ability to respond to economic fluctuations, such as recessions or emergencies, when deficit spending may be necessary to stabilize the economy

government/national debt

the accumulaton of past budget deficits minus past budget surpluses

when a govt. is in a deficit, how do they get funds?

borrowing money

• as the govt. runs deficits, their debt increases

public debt

government debt held by individuals and institutions outside the government

2 reasons for concern when a govt. runs persistent deficits

1. crowding out

   a. govt. competes w/ firms (financing IS) for money to borrow → increases IR → decreases IS → reduced growth + crowding out

2. current deficits that increase debt place pressure on future budgets

   a. govt. must pay bills → interest payments in debt

   b. must change T or G to fix gap, but with borrowing, they increase their debt even more

   c. at some point, lenders stop lending and the govt. may default

relationship for how a change in govt. borrowing impacts RGDP

increased borrowing → increased demand for loanable funds → increased real IR → decreased I and investment sensitive C → decreased AD → decreased RGDP

interest-sensitive consumption

consumption financed by borrowing

• ex: spending on houses and cars

default

borrower stops paying what they owe

• creates severe turmoil, high uncertainty, and low public confidence

why can’t the government just print money to pay off bills?

this can cause inflation

t or f: economists recommend that the govt. run deficits in bad years and surpluses in good years

yes

debt-GDP ratio

govt. debt as a percentage of GDP

• use this, instead of the size of debt, to assess government’s ability to pay off debt

• GDP = good indicator of potential T

• can fall even if debt increases (persistent deficit) as long as there’s GDP growth + inflation

how can governments “technically” run a budget deficit forever?

as long as the growth rate of GDP is greater than the growth rate of debt, the burden or paying that debt falls compared w/ the government’s potential tax revenue

implicit liabilities

spending promises made by governments that are effectively a debt despite the fact that they are not included in the usual debt statistics

• largest → Social Security + Medicare

• 3rd largest → Medicaid

• govt. promises transfers to current + future beneficiaries, creating future debt that isn’t included in statistics

t or f: Social Security, Medicare, and Medicaid make up an insignificant portion of federal spending

f: make up 40% of federal spending

what happens to tax revenue and transfer payments when the economy enters a recession?

tax revenue (profit) decreases, transfer payments rise (unemployment)

how can a govt. pay off debt w/o increasing a deficit?

• no borrowing

• contractionary fiscal policy

• print money