Chapter 18 Macroeconomics

When Governments are Borrowers in Financial Markets, there are 3 Possible Sources for the Funds from a Macroeconomic Point of View

Households might save more

Private firms might borrow less

More foreign financial investors from outside the country

National Saving and Investment Identity

Quantity supplied of financial capital=Quantity demanded of financial capital

S + (M-X) = I + (G-T)

S= saving by individuals and firms

(M-X)= imports (M) - exports (E) = trade deficit (or surplus)

I= private sector investment

G= government spending

T= taxes collected

Twin Deficits

Deficits that occur when a country is running both a trade and a budget deficit

A Budget Deficit Can Result in an Inflow of Foreign Financial Capital, a Stronger Exchange Rate, and a Trade Deficit

The U.S. budget deficit rises and foreign financial investment provides the source of funds for that budget deficit

This causes a stronger exchange rate

Makes it more difficult for exporters to sell their goods abroad while making imports cheaper, so a trade deficit (or a reduced trade surplus) results

A Series of Large Budget Deficits Can Become a Cause for Concern Among International Investors

This could lead to an outflow of international financial capital, which can cause a deep recession by:

-Depreciating the exchange rate

-Thus, reducing banks’ ability to repay international loans

-And reducing aggregate demand

Ricardian Equivalence

The theory that rational private households might shift their saving to offset government saving or borrowing

-If true, then any change in budget deficits or budget surpluses would be completely offset by a corresponding change in private saving

-Changes in government borrowing would have no effect at all on either physical capital investment or trade balances

The Underpinnings of Economic Growth are Investments in Physical Capital, Human Capital, and Technology

Set in an economic environment where firms and individuals can react to the incentives provided by well-functioning markets and flexible prices

Government Spending Can Also Encourage Certain Elements of Long-Term Growth

Spending on roads or water systems, on education, or on research and development that creates new technology

Types of Public Physical Capital

Transportation

Community and regional development

Natural resources and the environment

Education, training, employment, and social services

Other Government Programs Seek to Increase Human Capital Either Before or After the K-12 Education System

Head-Start Program

Government also provides support for universities and colleges

Head-Start Program

A program for early childhood education directed at families with limited educational and financial resources

About 1/5th of U.S. R&D Spending Goes to Defense and Space-Oriented Research

Defense-oriented R&D spending sometimes produces consumer-oriented spinoffs, but is less likely to benefit the civilian economy than direct civilian R&D spending

Fiscal Policy Can Encourage R&D Using Either Direct Spending or Tax Policy

Spend more on the R&D in government laboratories

Expanding federal R&D grants to universities and colleges, nonprofit organizations, and the private sector

Tax incentives which allow firms to reduce their tax bill as they increase spending on R&D