Understanding Fiscal Policy

Revenues vs. Expenses  Budgets: tools used by consumers and the government to better manage their resources  Federal Budget: a written document indicating the amount of money the government expects to receive for a certain year and authorizing the amount the government can spend that year.  Fiscal Year: a twelve-month period that can begin on any date. The federal budget takes about 18 months to prepare

Government Spending Decisions: Forces Affecting Government Spending Decisions Economic Forces Changes in the economy: growth rates, interest rates, employment rates, income distribution, and other indicators. Differing opinions about how changes in taxation would affect the economy Political Forces Desire of members of Congress to please constituents Different views of the political parties Cultural Forces American belief in limited government American belief in economic freedom Psychological Forces Individual beliefs about the role of government Individual attitudes toward paying taxes

Government Spending 2012  Mandatory Medicare/Medicaid : 20%  Mandatory Social Security: 20%  Defense Discretionary: 23%  Other Discretionary: 14%  Other Mandatory: 17%  National Debt Interest: 6%

Budget Terms  Balanced Budget = revenues are the same as expenditures  Budget Surplus = annual revenues are higher than spending  Budget Deficit = government expenditures exceed government revenues

If in a Deficit…………….  Must find a way to pay for the extra expenditures  Two possible solutions  Create money  Can lead to inflation or hyperinflation  Borrow money  Treasury bill, notes and bonds  Other countries own our national debt

Treasury Securities  Treasury bill  a government bond that is repaid within three months to one year  Treasury note  a government bond that is repaid within two to ten years  Treasury bond  a government bond that can be issued for as long as 30 years

National Debt  The sum of all the yearly deficits  As of November 27, 2012 the national debt was $17.5 trillion  The estimated population of the United States is 317,923, 865  So, each citizen's share of this debt is $193,397.  The National Debt has continued to increase an average of $3.88 billion per day since September 28, 2007!

Factoids about the Debt  GDP = trillion  95% debt to GDP  Daily increase of debt = $3.88 billion  Hourly increase of debt = $154 million  Second increase of debt = $43,000  Interest on the debt is the third single largest budget item (Social Security and defense)  Paying interest means we cannot spend money elsewhere in the U.S.

What can be done?  Balance the Budget  Increase Taxes  Decrease Spending  No Pork Barreling  Term Limits on Congress  Reduce Foreign Aid, Grants, Etc.

Stabilization of Economy  The government’s economic priorities are seen by analyzing the budget.  Also can be seen by the way they use Fiscal Policy  Fiscal means “basket” or “bag”, or “pool of money” (Latin, not Greek)  Specifically, money held by the government

Definition  Fiscal policy is a way of managing the nation’s financial affairs through a program of expenditures and taxation.  Purpose is to achieve particular economic goals  Stabilization

Two Types of Fiscal Policy 1. Expansionary Fiscal Policy  Increase Government spending and/or  Decrease Government taxes  Objective of this type of policy is to increase total spending in the economy to reduce the unemployment rate.  Encourage growth in the economy  Multiplier Effect – the idea that every one dollar of government spending creates more than one dollar in economic activity

2. Contractionary Fiscal Policy  Decrease Government spending and/or  Increase Government taxes  Objective is to reduce total spending in the economy in order to reduce inflation  Cool the economy down

Limits of Fiscal Policy  Clumsy and difficult to put into practice.  Hard to know real status of the economy.  Lag time can be up to 18 months  Political pressure from constituents  Hard for branches to work together  Temporary fix, could slide into recession

Classical Economists  Looked at supply and demand of individual products, not the aggregate (whole) economy  Believed it would move to equilibrium on its own, no government interference  Adam Smith  David Ricardo  Thomas Malthus

Keynesian Economists  Looked at the economy as a whole  Looked at productive capacity (maximum output that an economy can produce without big increases in inflation)  John Maynard Keynes  “In the long run we are all dead.”  Could not wait for the economy to recover on its own, challenged Classical view

Terms to Know  Demand-side economics - idea that government spending and tax cuts help an economy by raising demand  Keynesian economics - a form of demand-side economics that encourages government action to increase or decrease demand and output  Supply-side economics – a school of economics that believes tax cuts can help an economy by raising supply (Reaganomics)

Fiscal Policy History  Hoover and previous – Classical  FDR – Keynesian – war spending  1945 – 1960 – let the good times role  Kennedy – 6.7% unemployment – cut income taxes from 90% to 35%  Vietnam War increased spending and had the look of Keynesian success  Late 1970’s – unemployment and inflation  1981 – Reaganomics – cut taxes by 15% over three years – huge deficits because of spending

How successful do you think Fiscal Policy Is?