Long Run Implications of Fiscal Policy: Deficits and the Public Debt - Section 6, Module 30
Budget balance = the difference between the government’s tax revenue and spending [on goods and services and on govt transfers]
B = T - G - TR (tax revenue — government purchases of goods and services — govt transfers)
budget surplus = (+) and budget deficit = (-)
expansionary fiscal policies decrease the budget balance and contractionary fiscal policies increase the budget balance
changes in the budget balance can be used to assess whether a policy is expansionary or contractionary
can be misleading bc:
2 diff changes in fiscal policy can have the same effect on the budget balance but diff effects on the economy
changes in budget balance are often the result (not cause) of fluctuations of the economy
strong relationship btwn budget balance and business cycle
budget moves into deficit when economy goes into recession and vice versa
relationship is even clearer when the unemployment rate is compared with the budget deficit as a percent of GDP (direct relationship)
the relationship is not solid proof that policy makers engage in discretionary fiscal policy bc the relationship is generally caused by automatic stabilizers
important to separate movements in the budget balance due to business cycle with movements due to discretionary fiscal policy changes
automatic stablizers vs deliberate changes in govt purchases/transfers/taxes
business cycle effects on budget balance are temporary bc in the long run, recessionary/expansionary gaps are eliminated
the govts tax and spending policies need to yield enough revenue in the long run to fund its spending
cyclically adjusted budget balance - an estimate of what the budget balance would be if real GDP = LRAS [potential output] → separates the effect of the business cycle from other effects
budget balance if there were no recessionary or inflationary gap
takes into account the tax revenue/transfers the govt would collect/save if the recessionary gap was eliminated or the revenue the govt would lose/transfer it would make if the inflationary gap was eliminated
budget defecitis can cause issues, but politicians are tempted to run deficits bc then they can increase spending without increasing taxes
however, forcing a balanced budget every year is also bad - govt should run in deficit for a few years, then surplus and cancel out
govt debt - accumulation of past budget deficitis minus past budget surpluses
continuous govt borrowing leads to crowding out:
todays deficits places financial pressure on future budgets
bc of interest
to pay off suhc large amounts of interest, govt either has to incr taxes, spend less, or borrow more to cover the gap
but by borrowing, the debt increase more
eventually lenders will lose faith in the govt to repay - no more funds fro the govt to borrow
govt will defualt on its debt - stop paying what it owes 💀💀💀💀
and govt cant j print more money to cover debt = inflation
govts should offset deficits through surpluses
debt-gdp ratio - the govts debt as a % of their GDP
if the govts debt grows slower than the gdp, the burden of oaying the debt is decr compared to potential tax revenue
modern govts can run deficits for a whild bc if their econ grows, it cancels out
debt-gdp ratio can fall even as debt is incr
implicit liabilities = spending promises mad eby govts that are basically a debt even tho they are NOT INCLUDING IN DEBT STATISTICS
largers ILs of US are from transfer paymesnt - SS[n] anad medicare and medicaid
govt has promosed to provide transfer payments to the benefiiciaresi - so future debt
dedicated taxes = expenses are paid out of special taxes on wages - pay for medicare and ss[n]
some is technically counted in debt statistics social security trust fund - surplus in the ss system bc ss has been taking up more revenue than needed immediately (to prepare for the future)
the money is held in the form of govt bonds which IS counted in total debt