{ Module 30: Long- Run Implications of Fiscal Policy Deficits and the Public Debt

 Juice box bonus is due 3 Dec  If you would like to do a white elephant we need to talk about it:  It will be a slight economic experiment (and fun)  We will see who can get the best deal on something for the set price  The person who gets the best “deal” according to the class, wins Announcements

 It’s a quick measure of whether the economy is expansionary or contractionary but there are two reasons why this can be misleading:  Changes in fiscal policy do not always have the same effect  i.e. gov’t purchases have a much larger effect on rGDP than equal-sized changes in taxes and transfers  Changes in the budget balance are the result of fluctuations in the economy Is the Balanced Budget a Good Measure of the Economy?

 E economy (recession)= d deficit  E economy (expansion) = d deficit (sometimes surplus) Business Cycle and the Cyclically Adjusted Budget Balance

 I deficit = r unemployment  Why?  Largely b/c automatic stabilizers kick in with recession and reduce with expansion Unemployment and Budgets

The Federal Government should be required to always maintain a balanced budget. Four-Corner Debate

 Most economists believe its only necessary on average  Run a deficit on bad years and surplus on good years  Forcing it to happen every year was negate the automatic stabilizers and taxes  Tax revenue I and transfers I helps to reduce size of recessions Balance the Budget?

 Tried with social spending in 1919 but the amount they were paying per citizen was far higher than what they were taking in so they took out loans  1913 – 20.5 marks per person  1925 – 65 marks per person  1929 – over 100 marks per person  The failure of the German economy was not due to debt though, much of it was because they could not get their budgets in order and it led to spiraling deficit spending  In 1913 – 53% of all tax revenues was from income  By 1925 – that was 28%  But this wasn’t all – the German could not sell goods to foreign countries because of protective tariffs placed on German goods  So they were attempting to sell goods to people in their country who had no money  This will all lead to them printing excess money which is what everyone realizes is the inflation of the German economy  This lead to money hoarding or money destruction which forced the Weimar Republic to print more money  Leading to a cyclical deflation of money and skyrocketing gov’t deficit that threatened to collapse Germany Closer look at Germany

 Dawes Plan 1924  Negotiations between the United States and Germany for a plan to coordinate payments on debts and make the deficit more manageable  Reduced payments until 1929 when it was to be reevaluated  Reparations payments in 1922 were $2 billion but in 1924, they were set at $50 million  This was combined with a loan of $200 million from the US gov’t to improve infrastructure  Helped to stabilize the economy  Forced Germany to put checks and fiscal measures into place to keep inflation and exchange rates at acceptable levels  Gold reserve was set to 30% of all money in circulation  By 1927 the Weimar Republic felt comfortable putting guarantees of income for low earners in place (one of those automatic stabilizers)  Seemed to lead to an economic recovery, from the cost of living fell and the standard of living rose  Industrial output had doubled by 1929 and the Germans were able to start repaying reparations  But then the Depression hit and damaged a lot of this growth as the US started to call in the loans it had just made 5 years earlier

 Debt – GDP ratio tells economists how well the gov’t can pay back debt  Dangerous when debt grows faster than GDP  Possible to run a deficit for many years as long as the GDP is rising faster than the debt Deficits and Debt in Practice

US Budget Deficit Japanese Budget Deficit

 Spending promises made by gov’ts that are effectives a debt despite the fact that they are not included in the usual debt statistics  Ex:  Social Security  Medicare  Medicaid Implicit Liabilities

Social Security should be eliminated. Four-Corner Debate