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 both.
  • Aims to create a deficit.
  • Multiplier effect: Initial spending increase leads to a larger increase in aggregate demand.

Contractionary Fiscal Policy

  • Used during demand-pull inflation.
  • Involves decreasing government spending, increasing taxes, or both.
  • Aims to create a budget surplus.

Built-In Stability

  • Automatic stabilizers: Taxes vary directly with GDP, transfers vary inversely.
  • 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, tax cuts.
  • Great Recession: Financial market problems, credit market freeze, recession from December 2007, slow recovery.

Problems and Criticisms of Fiscal Policy

  • Timing issues: Recognition lag, administrative lag, operational lag.
  • Political considerations and future policy reversals.
  • Offsetting state and local finance and 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 About U.S. Public Debt

  • Interest charges (1.8% of GDP in 2018).
  • False concerns: Bankruptcy, refinancing, taxation, burdening future generations.
  • Substantive issues: Income distribution, incentives, foreign-owned public debt, crowding-out effect.

Social Security and Medicare Time Bombs

  • More Americans receiving benefits as they age.
  • Social Security shortfalls: Funds depleted by 2033.
  • Medicare shortfalls: Funds depleted by 2024.

Possible Solutions

  • Increasing retirement age.
  • Increasing the portion of earnings subject to social security tax.
  • Disqualifying wealthy individuals.
  • Redirecting low-skilled immigrants.
  • Defined contribution plans.