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

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

Pop Quiz 1.To fight a recession, the government should ______ taxes and _____ government spending. 2.This expansionary policy could create a budget _________ and may __________interest rates as the government has to borrow more. This is known as the _______________________. 3.Everybody knows that if interest rates go up this will __________ foreign financial investment in the U.S. causing the dollar to _______________ in foreign exchange markets and causing net exports to go __________ lower Increase DeficitIncrease Crowding out effect increase Appreciate Down!

Pop Quiz 1.To fight a recession, the government should ______ taxes and _____ government spending. 2.This expansionary policy could create a budget _________ and may __________interest rates as the government has to borrow more. This is known as the _______________________. 3.Everybody knows that if interest rates go up this will __________ foreign financial investment in the U.S. causing the dollar to _______________ in foreign exchange markets and causing net exports to go __________ lower Increase DeficitIncrease Crowding out effect increase Appreciate Down!

Pop Quiz 1.To fight a recession, the government should ______ taxes and _____ government spending. 2.This expansionary policy could create a budget _________ and may __________interest rates as the government has to borrow more. This is known as the _______________________. 3.Everybody knows that if interest rates go up this will __________ foreign financial investment in the U.S. causing the dollar to _______________ in foreign exchange markets and causing net exports to go __________ lower Increase DeficitIncrease Crowding out effect increase Appreciate Down!

Pop Quiz 1.To fight inflation, the government should ______ taxes and _____ government spending. 2.This contractionary policy could create a budget _________ and may __________interest rates as the demand for borrowed funds goes __________. 3.Everybody knows that if interest rates go down this will __________ foreign financial investment in the U.S. causing the dollar to _______________ in foreign exchange markets and causing net exports to go __________ 4.This net export effect (compliments/offsets) the contractionary effort. _____________ increase decrease surplusdecrease depreciate Up. down offsets

“Ten Things To Know About The Federal Budget” 1.The 2009 federal budget will start on ______________ and end on ________________. 2.What do economists like to compare a budget deficit to when determining its relative size? 3.Has federal spending grown in the last 50 years? Oct. 1, 2008 September 30, 2009 The deficit as a percentage of GDP Nominally yes, but is still between 18-20% of total spending

4.According to the reading, what percent of federal spending goes to defense? How much of our GDP does that represent? 5.What trade-off is involved in the growing size of entitlement programs? 6.What, if anything, is disturbing about financing some of our debt with our buddies in China and Japan? 20% or 4 % of our GDP Less discretionary spending Factor income leaving the country/transfers economic resources abroad

DEFICITS, SURPLUSES, AND DEBT Definitions: Budget Deficit Budget Surplus National or Public Debt U.S. Securities

Causes: Wars Recessions Tax Cuts THE PUBLIC DEBT Facts and Figures: Quantitative Aspects Debt and GDP International Comparisons Interest Charges Ownership

Italy Japan Belgium Canada Spain France Germany United States Netherlands Finland Sweden Denmark United Kingdom Australia GLOBAL PERSPECTIVE Public Sector Debt as a percent of GDP, 2000 Source: Organization for Economic Cooperation and Development

Social Security Considerations Social Security Trust Fund THE PUBLIC DEBT False Concerns Bankruptcy Refinancing Taxation Burdening Future Generations

OWNERSHIP OF THE PUBLIC DEBT 9% 28% 11% 22% 13% 17% Debt held By Federal Reserve & Government Agencies Debt held Outside the Federal Reserve & Government Agencies Federal Reserve U.S. Government Agencies Other, Including State & Local Governments U.S. Banks & Financial Institutions Foreign Ownership U.S. Individuals

I D1 Investment (billions of dollars) Real interest rate (percent) THE CROWDING OUT EFFECT With a Deficit, An Increase in Investment Demand Causes… I D2 Crowding Out Effect

DEFICITS AND SURPLUSES Source: Economic Report of the President, 2001 $ Budget Deficits or Surpluses, Billions Actual Projected (as of 2001)

Federal Budget Deficits and Surpluses Actual and Projected, Fiscal Source: Congressional Budget Office $ Budget Deficit (-) or Surplus, Billions ActualProjected(as of March 2006)

Social Security Trust Fund (social insecurity ) Many claim Social Security may go bankrupt soon due to BABY BOOM Retirement 1 st Boomer Retires

Ways to save Social Security

Ways to save social security 1. Delay Retirement Age

2.Means Test  Only give it to those who need it 3.Raise the social security tax  currently 6.2% 4. Increase maximum amount of income that can be taxed (cap)…currently the income max is $97,500

5.Reduce Benefits 6.Privatize Accounts

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

Standardized Budget versus the Actual Budget The Standardized Budget… measures the Federal budget deficit or surplus that would occur if the economy operated at full employment throughout the year. (full employment budget) Cyclical deficits or surpluses are those that result from changes in GDP. (actual deficits/surpluses that occur automatically) Changes in the standardized deficit or surplus indicate whether the government is engaging in expansionary or contractionary fiscal policy. Changes in the actual budget deficit or surplus do not since the deficits or surpluses can include cyclical deficits or surpluses

(1) Year (2) Actual Deficit (-) or Surplus (+) (3) Standardized Deficit (-) or Surplus (+) Recent U.S. Fiscal Policy % -4.4% -4.5% -3.8% -2.9% -2.2% -1.4% -0.3% +0.8% +1.4% +2.5% +1.3% -1.5% -3.4% -3.5% -2.6% -2.2% -2.5% -2.9% -2.1% -2.0% -1.2% -1.0% -0.4% +0.1% +1.1% -1.1% -2.7% -2.4% -1.8% Federal Deficits and Surpluses – as a Percentage of Potential GDP Source: Congressional Budget Office Expansionary