FISCAL POLICY, DEFICITS AND DEBT Pertemuan 9 Matakuliah: J0594-Teori Ekonomi Tahun: 2009

Bina Nusantara University 3 Fiscal Policy and the AD-AS Model Expansionary Fiscal Policy Increased Government Spending Tax Reductions Some Combination of the Two Contractionary Fiscal Policy –Decreased Government Spending –Increased Taxes –Some Combination of the Two

Bina Nusantara University 4 Fiscal Policy and the AD-AS Model Real Domestic Output, GDP Price Level AD 3 Recessions Decrease Aggregate Demand AD 4 $5 Billion Initial Decrease In Spending Full $20 Billion Decrease in Aggregate Demand AS $510$522 P1P1 Contractionary Fiscal Policy

Bina Nusantara University 5 Fiscal Policy and the AD-AS Model Real Domestic Output, GDP Price Level AD 2 Recessions Decrease Aggregate Demand AD 1 $5 Billion Additional Spending Full $20 Billion Increase in Aggregate Demand AS $490$510 P1P1 Expansionary Fiscal Policy

Bina Nusantara University 6 Built-In Stability Economic Importance Tax Progressivity Automatic or Built-In Stabilizers –Progressive Tax System –Proportional Tax System –Regressive Tax System

Bina Nusantara University 7 Built-In Stability G T Deficit Surplus GDP 1 GDP 2 GDP 3 Real Domestic Output, GDP Government Expenses, G and Tax Revenues, T

Bina Nusantara University 8 Evaluating Fiscal Policy Standardized Budget (Full-Employment Budget) Cyclical Deficit Recent U.S. Fiscal Policy Budget Deficits and Projections Social Security Considerations

Bina Nusantara University 9 Evaluating Fiscal Policy G T GDP 2 GDP 1 Real Domestic Output, GDP Government Expenses, G and Tax Revenues, T (Year 2)(Year 1) $500 $450 a b c

Bina Nusantara University 10 Evaluating Fiscal Policy G T1T1 GDP 4 GDP 3 Real Domestic Output, GDP Government Expenses, G and Tax Revenues, T (Year 4)(Year 3) $500 $450 d e f $475 $425 g T2T2 h

Bina Nusantara University 11 The Public Debt National or Public Debt $7.96 Trillion Ownership –U.S. Securities –42% Owned by Federal Government and Federal Reserve –58% Held Outside the Federal Government and Federal Reserve Graphically…

Bina Nusantara University 12 The Public Debt Debt Held by the Federal Government and Federal Reserve (51%) Debt Held Outside The Federal Government and Federal Reserve (49%) Federal Reserve U.S. Government Agencies U.S. Individuals Foreign Ownership U.S. Banks And other Financial Institutions Other – Including State and Local Governments Source: U.S. Treasury 9% 8% 25% 8% 42% Total Debt $7.96 Trillion

Bina Nusantara University 13 Debt and GDP Interest Charges False Concerns –Bankruptcy –Refinancing –Taxation –Burdening Future Generations

Bina Nusantara University 14 Debt and GDP Substantive Issues –Income Distribution –Incentives –Foreign-Owned Public Debt –Crowding-Out Effect Revisited Graphically …

Bina Nusantara University 15 Debt and GDP The Investment Demand Curve and the Crowding-Out Effect Real Interest Rate (Percent) Investment Demand (Billions of Dollars) ID 1 ID 2 a bc Interest Rate Rise Will Decrease Investment a to b Crowding- Out Effect A Large Public Debt to Finance Public Investment Will Cause… If Public Spending Spurs More Private Investment Will Increase to ID 2

Bina Nusantara University 16 Debt and GDP Public Investments and Public-Private Complementarities Public Investments –Public Goods Spending –Human Capital Spending –Reduction on Crowding-Out Effect