Fiscal Policy, Deficits, and Debt

Fiscal Policy

• Deliberate changes in government spending and taxes to achieve full employment, control inflation, and encourage economic growth.
• Can be discretionary or nondiscretionary.
• Expansionary Fiscal Policy:
  • Used during a recession.
  • Involves increasing government spending, decreasing taxes, or a combination of both.
  • Aims to create a deficit.
• Contractionary Fiscal Policy:
  • Used during demand-pull inflation.
  • Involves decreasing government spending, increasing taxes, or a combination of both.
  • Aims to create a budget surplus.

Built-In Stability

• Automatic stabilizers:
  • Taxes vary directly with GDP.
  • Transfers vary inversely with GDP.
• Tax progressivity:
  • Progressive, proportional, and regressive tax systems.

Evaluating Fiscal Policy

• Determine if fiscal policy is expansionary, neutral, or contractionary.
• Use the cyclically adjusted budget to evaluate.

U.S. Fiscal Policy

• 2000-2007: Full employment, tech stock bubble burst, terrorist attack (2001), tax cuts (2002, 2003).
• Great Recession: Financial market problems (2007), credit market freeze, recession (Dec 2007, lasted 18 months).

Problems and Criticisms of Fiscal Policy

• Timing issues: Recognition, administrative, and operational lags.
• Political considerations and potential future policy reversals.
• Offsetting state and local finance.
• Crowding-out effect.

U.S. Public Debt

• $22.1 trillion in April 2019$: Accumulation of federal deficits and surpluses.
• Owed to holders of U.S. securities (Treasury bills, notes, bonds, savings bonds).
• Concerns:
  • Interest charges (1.8% of GDP in 2018).

Social Security and Medicare

• Potential shortfalls due to more Americans receiving benefits as they age.
• Social Security funds may be depleted by 2033.
• Medicare funds may be depleted by 2024.
• Possible solutions: increasing retirement age, increasing the portion of earnings subject to social security tax, etc.