Warm-Up You are an economic adviser to a candidate for national office. She asks you for a summary of the economic consequences of a balanced-budget rule for the federal government and for your recommendation on whether she should support such a rule. How do you respond?

Warm-UP What is the difference between a budget surplus and a budget deficit? Is it always better to have one over the other? US National Debt

Long-Run Implications of Fiscal Policy Chapter 29: Fiscal Policy (pages 779-789)

Budget Balance Savings by government SGovernment = T – G – TR SGovernment > 0  SURPLUS SGovernment < 0  DEFICIT

Visualizing U.S. Deficits How large is the deficit? What would cutting it look like? The money hole… Visualized in $100 bills

Scenario 1: Recessionary Gap LRAS SRAS AD2 AD1

Scenario 1: Recessionary Gap Fiscal policies include: Cutting taxes Increasing government spending Increasing transfer payments Reduces budget balance

Scenario 2: Inflationary Gap LRAS SRAS AD2 AD1

Scenario 2: Inflationary Gap Fiscal policies include: Increasing taxes Cutting government spending Cutting transfer payments Increases budget balance

Budget Balance and Cycles…

Budget Balance and Cycles… Changes to budget caused by AUTOMATIC STABILIZERS Need better measure CYCLICALLY ADJUSTED BUDGET BALANCE Budget balance if GDP = Yo

Should We Always Balance? Scenario: Recessionary Gap Tax revenue is falling Budget balance declining Options include: Increase taxes Cut spending All options make problems WORSE

Should We Always Balance? Economists recommend balance ON AVERAGE Deficits during bad years Surpluses during good years Difficult to achieve in real life

Is Debt a Problem? www.usdebtclock.org Concerned with PUBLIC DEBT Held by individuals and institutions Nearly $9 trillion in US Expressed as % of GDP

Is Debt a Problem? Yes… Reason 1: Crowding out S Real interest rate D1 DPrivate sector

Is Debt a Problem? Yes… Reason 2: Future financial pressure Must borrow to pay debt Creates vicious cycle Takes away funds for future projects

How Big a Problem Is it? Measured by DEBT-GDP RATIO QUESTION: Does the US have worse debt than Canada?

Something Else to Worry About Be aware of IMPLICIT LIABILITIES Future spending promises Add to overall debt EXAMPLES: Medicare, Medicaid and Social Security Make up nearly 50% of budget already Will only grow with time

Implicit Liabilities

Who Do We Owe? http://www.washingtonpost.com/blo gs/worldviews/wp/2013/10/10/this- surprising-chart-shows-which- countries-own-the-most-u-s-debt/

Mini-FRQ Time… Consider the information in the chart Answer questions on your handout Country of Zeta Amount Tax revenues $2,000 Government purchases $1,500 Government transfers $1,000 Real GDP $20,000 Potential output $18,000