Lecture 9

Definition: Changes to existing taxation and spending programs, intended for increasing or decreasing total spending in the economy.

Discretionary Fiscal Policy is typically associated with Keynesian theories:
- Expansionary Fiscal Policy: Intended to increase total spending for recessionary gaps.
- Contractionary Fiscal Policy: Intended to decrease total spending for inflationary gaps.

Discretionary Fiscal Policy must be approved by:
- Legislative Branch (Congress): Responsible for passing fiscal laws.
- Executive Branch: Responsible for carrying out the approved policies.

Budget Deficit (G > T): An excess of government spending over tax revenue.
Government Debt: The accumulation of past government borrowing.
Budget Surplus (T > G): An excess of tax revenue over government spending, leading to the ability to repay some government debt.
Balanced Budget (G = T): When government spending equals tax revenue.

**Budget Deficits: **
- Reduce national saving.
- Decrease the supply of loanable funds.
- Result in rising interest rates and falling investment.
Budget Surpluses:
- Increase national saving.
- Increase the supply of loanable funds.
- Reduce interest rates and stimulate investment.

For the discussion on fiscal policy:
- $GDP = C + I + G + NX$ (open economy)
- For a closed economy: $GDP = C + I + G$

Tools of Expansionary Fiscal Policy:
- Increase government spending (G).
- Decrease taxes (which increases consumption (C) and investment (I)).

Definition: Government resorts to borrowing money instead of taxing citizens.
Example to illustrate difference: Comparing borrowing from a brother when young to taxation.

Defined as government-issued I.O.U.s promising to pay the holder a specific amount at a future date.
Treasury Bonds: U.S. government bonds issued by the Treasury Department, representing government debt securities.

Government Financing Deficits: Occurs through borrowing via the sale of government bonds.
Debt-to-GDP Ratio: A measure of government indebtedness relative to the ability to raise tax revenue, with notable behaviors:
- Rises during wartime.
- Falls during peacetime until the early 1980s.
- Increases during economic downturns.
Graph Reference: U.S. government debt as a percentage of GDP from 1971-2020 (exact data not provided, refer to sources).

Burden on Future Taxpayers: Government debt impacts future individuals through increased taxation.
Investment Crowding Out: Deficits may lead to higher interest rates, insufficient investment reduces overall growth.

Exaggeration of Debt Concerns: Debt is a small percentage of an individual's lifetime income.
Potential Harm from Cutting the Deficit:
- Reductions in education may hinder human capital growth and future living standards.
- Increased taxes may disincentivize work and savings efforts.
Focus on Debt/Income Ratio: This ratio may be more relevant than the absolute debt amount.

Definition: A policy that entails decreasing government spending and increasing taxes.

Definition: Effects from private individuals, households, and businesses that counter government policies, reducing effectiveness.

Crowding Out Effect: Increased government borrowing may elevate interest rates, reducing private investment due to limited funds available for households and businesses.
Ricardian Equivalence: Suggests that government borrowing parallels taxation; reducing taxes without real income change may not incentivize spending.
- Example: Government cuts taxes while borrowing the same amount, leading to no real benefit for the taxpayer in terms of spending capabilities.
Direct Expenditure Offsets: If government spending substitutes for private sector spending, it doesn’t increase total spending.
- Example: Providing free milk may reduce personal spending on the item, leading to dollar-for-dollar offsets without increases in total spending.

Supply-side Economics: Advocates argue tax cuts can increase real GDP by enhancing supply rather than demand.
- Lower marginal tax rates are said to incentivize workers to enhance productivity.
- Conversely, higher marginal rates can suppress productivity.

Visual Concept: Represents the relationship between tax rates and tax revenue, indicating how tax cuts might lead to higher revenue by boosting economic activity.

Recognition Time Lag: The duration needed to assess the current state of the economy accurately.
Action Time Lag: The period between recognizing an economic issue and the enactment of policy solutions, often long due to the requirement of congressional approval.
Effect Time Lag: The interval that elapses between policy implementation and observable effects on the economy.

Definition: Policies that automatically take effect without needing congressional approval, thus stabilizing the economy.

Tax System: A reduction in income leads to lower tax revenues, thus acting as an automatic tax cut during recessions.
Unemployment Compensation: Provides stability to aggregate demand when individuals are unemployed, thus reducing negative economic impacts.
Income Transfer Payments: Programs like Supplemental Security Income and Temporary Assistance stabilize aggregate demand during downturns when incomes fall.