$20 Trillion and Counting Fiscal Policy and Debt

Who Pays?

National Debt U.S. National Debt Clock : Real Time http://www.npr.org/blogs/money/2013/10/10/230944425/everyone-the-u-s-government-owes-money-to-in-one-graph?utm_medium=Email&utm_source=DailyDigest&utm_campaign=20131010

National Debt The amount of money that the US has borrowed to fund deficits in the Government Budget. The current figure is now over $20 trillion. In 2004, this total was a little over $7 trillion.

US Debt Visualization of US Debt

Deficits “Christmas is a time when kids tell Santa what they want and adults pay for it. Deficits are when adults tell the government what they want and their kids pay for it.” Richard Lamm Curmudgeon Compiled by Jon Winkler Funny Times Dec, 2013

Spending Levels and Allocation By table, please complete the first column in the handout. http://www.usgovernmentspending.com/us_budget_pie_chart Now complete the third column assuming that government spending has to decrease by 10%.

Good or Bad? All debt has to be put in perspective. Questions that are relevant include: What was the benefit from the money borrowed? How does the repayment of the debt compare to the income of the government? What are the impacts of this debt on other areas of the economy (crowding out effect)? What is the cost of the money borrowed? Who do we owe the money to?

How Are We Doing? Based on the five questions on the previous slide, how would you assess what we are doing?

Fiscal Policy Government actions with regard to government spending and taxes in order to impact the economy These actions are based on the presumption that the economy will not just fix itself. Classical Theory assumes that the economy will fix itself over time. Fiscal Policy is on pages 206-210 in the AP Economics book from Princeton Review.

Fiscal Policy “Changes in government spending and tax collection designed to achieve full employment and noninflationary domestic output.” Essentials of Economics; Brue and McConnell

What To Do, What To Do? The basic question is what can the government do to help keep stability in the economy? What tools does the Government have at its disposal to help influence the direction of the economy?

Expansionary Policy Options in a Recession: Increase Government Spending Increase transfer payments to citizens Decrease Taxes Combination of the above

Expansionary Policy AD shift to right; Why? Increase in deficit; Why or why not?

Economy Too Strong? When will this happen? Demand Pull Inflation Contractionary Policy: Decrease Government Spending Decrease transfer payments Increase Taxes

Contractionary Policy Shift AD Curve to the left; Why? Improve deficit; Why or Why not?

Multiplier Effect- Government Government Spending: The multiplier for government spending is the same as the one we talked about earlier. Thus, government spending in multiplied by 1/MPS. This assumes that all of the dollars spent by the government will go to the sellers of goods and services.

Multiplier Effect- Tax Changes When the government changes taxes or transfer payments the calculation is different. In this case, it is assumed that a portion of the amount is saved (MPS). In this case the multiplier becomes MPC/MPS. For example, if the MPC is .75 and the MPS is .25, then the multiplier becomes 3 (.75/.25).

Balanced Budget Multiplier If the government increases spending, but at the same time increases taxes (to balance the budget), then the change is only equivalent to the initial changes from the increased spending and increased taxes.

Crowding Out Effect Government actions increase deficit to stimulate economy; Increased deficit drives up government demand for debt; This increases interest rates overall; Increased rates will dampen consumer and business spending.

Supply Side Economics Supply Side Economists argue that a change in tax rates can have an impact in the AS curve as well as the AD curve. With more money households will save more and business will invest more. This gives us more capital and higher productivity. Provides a greater incentive to work, thus increasing GDP. Encourages entrepreneurs to take more risk (Reward greater). This will lead to greater GDP as more products are developed.

Tax Cuts Potentially Tax cuts could cause both the AD curve and the AS curve to shift to the right. This would then lead to a further increase in real GDP. Supply side economists argue that a decrease in tax rates actually leads to an increase in tax revenues (due to higher GDP).

Laffer Curve Arthur Laffer developed the theory that there is a relationship between the tax rate and the amount of revenue a government will receive. http://www.investopedia.com/terms/l/laffercurve.asp

Automatic Stabilizers A built in stabilizer is anything that increases the government’s budget deficit (or reduces surplus) during a recession and increases its budget surplus (or reduces deficit) in an expansion. Examples: Progressive Tax Code (tax rates get higher as income increases)- Thus in expansion, incomes will grow and thus tax rates will increase. As taxes increase, this will put a drag on Ad and thus slow down the expansion. In a recession, the opposite this will occur. Unemployment Insurance will also help those who lose their jobs in a recession with income, thus dampening the impact of a recession.

Conclusions Suppose you had to discuss the benefits or costs of Fiscal Policy. What points would you make in support of Fiscal Policy? Allows gov’t to change economy; can be done quickly; can have direct impact on economy What arguments would you make in opposition to Fiscal Policy? Impact is uncertain; requires government to reach consensus; Crowding Out Effect

Problem For Government? Over the past 10 years or so, there has been very little action taken by Congress with regard to Fiscal Policy. Why? The only exception to this is 2008-2010 when the Democrats controlled both the House and the Senate as well as the Presidency. Government inaction has largely come as a result of the differences between the philosophies of the two parties leading the government.

Solution Suppose we could waive a magic wand and that you were in charge of Congress and could get them to enact your plan for “fixing” the economy. Using Fiscal Policy, what would you do? By table; design a plan that will be presented to class. First, define what you believe to be the problems in the US economy. Second, design a plan through the use of Fiscal Policy to fix these problems. Be specific in the design and show me the impact on AS/AD curves of your changes. Finally, tell me the concerns (problems) related to your solution.

Result of Government Inaction What do you think is the consequence of the lack of Fiscal direction from Congress over the last 10 years? Lack of Fiscal Policy has meant that the Fed and Monetary Policy (you will learn about this in the next unit) has been the only way that the government has been able to try to manipulate the economy.