Fiscal Policy, Deficits, and Debt

Fiscal Policy

• Definition: Deliberate changes in government spending and taxes to:
  • Achieve full employment.
  • Control inflation.
  • Encourage economic growth.

Expansionary Fiscal Policy

• Use: During a recession.
• Actions:
  • Increase government spending.
  • Reduce taxes.
  • Combination of both.
• Effect: Creates a deficit.
• Graphical Representation:
  • Aggregate Demand (AD) shifts rightward (e.g., from AD1 to AD2).
  • Real GDP increases (e.g., from $490 billion to $510 billion).
  • Price level may increase (e.g., from P1).

Contractionary Fiscal Policy

• Use: During demand-pull inflation.
• Actions:
  • Decrease government spending.
  • Increase taxes.
  • Combination of both.
• Effect: Creates a surplus.
• Graphical Representation:
  • Aggregate Demand (AD) shifts leftward (e.g., from AD3 to AD4).
  • Real GDP decreases (e.g., from $510 billion to $522 billion).
  • Price level decreases (e.g., from P2 to P1).

Built-in Stability

• Automatic Stabilizers:
  • Taxes vary directly with GDP.
  • Transfers vary inversely with GDP.
• Effect: Reduces severity of business fluctuations.
• Tax Progressivity: Plays a role in automatic stabilization.
• Graphical Representation:
  • Government expenditures (G) and tax revenues (T) plotted against Real GDP.
  • Deficit: G > T
  • Surplus: T > G

Cyclically Adjusted Budget Deficits

• Used to evaluate fiscal policy by adjusting for cyclical fluctuations in GDP.
• Compares government expenditures and tax revenues at potential GDP.

Evaluating Fiscal Policy

• Determine if the fiscal policy is:
  • Expansionary
  • Neutral
  • Contractionary
• Use the cyclically adjusted budget to evaluate.

Recent U.S. Fiscal Policy

• Federal Deficits and Surpluses as Percentages of GDP:
  • Table data from 2000-2009 and 2010-2018 showing actual and cyclically adjusted deficits/surpluses as percentages of potential GDP.
  • Example:
    • 2000: Actual Surplus = +2.4%, Cyclically Adjusted Surplus = +1.5%
    • 2009: Actual Deficit = -9.3%, Cyclically Adjusted Deficit = -7.6%
    • 2010: Actual Deficit = -8.3%, Cyclically Adjusted Deficit = -6.4%
    • 2018: Actual Deficit = -3.9%, Cyclically Adjusted Deficit = -3.9%

Fiscal Policy: The Great Recession

• Financial market problems began in 2007.
• Credit market freeze.
• Pessimism spreads to the overall economy.
• Recession officially began December 2007 and ended in summer of 2009.

Problems, Criticisms, & Complications of Fiscal Policy

• Problems of Timing:
  • Recognition lag
  • Administrative lag
  • Operational lag
• Political Considerations
• Future Policy Reversals
• Offsetting State and Local Finance
• Crowding-Out Effect

The U.S. Public Debt

• Amount: $27.9 trillion$ in February 2021.
• Accumulation of years of federal deficits and surpluses.
• Owed to holders of U.S. securities:
  • Treasury bills
  • Treasury notes
  • Treasury bonds
  • U.S. savings bonds

Holders of U.S. Public Debt (2018)

• Federal Reserve: $11\%$
• U.S. government agencies: $27\%$
• U.S. individuals: $9\%$
• Foreign ownership: $29\%$
• U.S. banks and other financial institutions: $8\%$
• Other (including state and local governments): $16\%$

Yearly U.S. Public Debt

• Federal debt held by the public as a percentage of GDP:
  • Less than $30\%$ in 1970.
  • Rose slowly to just under $50\%$ in the late 1990s.
  • Declined until the early 2000s, stopping at just over $30\%$.
  • Climbed again, jumping from $35\%$ in 2008 to more than $70\%$ in 2018.

Global Snapshot: Publicly Held Debt (International Comparisons - 2017)

• Japan: $239.9\%$
• Greece: $180\%$
• Italy: $130\%$
• Belgium: $115\%$
• Spain: $100\%$
• France: $95\%$
• Canada: $90\%$
• United States: $80\%$
• India: $70\%$
• Germany: $65\%$
• Netherlands: $58\%$

U.S. Public Debt Issues

• Interest Charges on Debt:
  • Largest burden of the debt.
  • $1.8\%$ of GDP in 2018.
• False Concerns:
  • Bankruptcy
  • Refinancing
  • Taxation
  • Burdening future generations

Substantive Issues Related to Public Debt

• Income distribution
• Incentives
• Foreign-owned public debt
• Crowding-out effect revisited
  • Future generations
  • Public investment

Social Security Shortfalls

• More Americans will be receiving benefits as they age.
• Since 2009, annual revenues fall below payouts.
• Funds will be depleted by 2033.

Social Security Options

• Increasing the retirement age.
• Increasing the portion of earnings subject to the Social Security tax.
• Disqualifying wealthy individuals.
• Redirecting legal immigration toward high-skilled, high-earning entrants.
• Placing payroll tax revenues into accounts owned by individuals.