Economics for your Classroom from Ed Dolan’s Econ Blog US Budget Deal Locks in Tight Fiscal Policy Posted December 12, 2013 Ed Dolan’s Econ Blog Terms of Use: These slides are provided under Creative Commons License Attribution—Share Alike 3.0. You are free to use these slides as a resource for your economics classes together with whatever textbook you are using. If you like the slides, you may also want to take a look at my textbook, Introduction to Economics, from BVT Publishing.Attribution—Share Alike 3.0 Introduction to Economics

December 12, 2013 Ed Dolan’s Econ Blog Ed Dolan’s Econ Blog The December Budget Deal  In early December Senator Patty Murray (D-WA) and Representative Paul Ryan (R-WI) reached a proposed budget deal that would set U.S. fiscal policy for the next two years  Main points:  Relaxes “sequester” restrictions  Small increases in some spending programs  Spending increases offset by increases in government fees  Little change (slight reduction) in overall deficit projection Senator Patty Murray Representative Paul Ryan

December 12, 2013 Ed Dolan’s Econ Blog Ed Dolan’s Econ Blog Government Contribution to GDP Growth  The budget deal comes at a time when the federal government’s contribution to GDP growth has been negative for 10 of the past 12 quarters  For most of that time, state and local government has also made a negative contribution to growth  The negative growth contribution means that fiscal policy has, on balance, slowed the recovery

December 12, 2013 Ed Dolan’s Econ Blog Ed Dolan’s Econ Blog Federal Employment  Total federal employment provides another perspective on the trend in fiscal policy  Since the expiration of the temporary stimulus of 2009 and temporary census hiring in 2010, federal employment has been falling  It is now lower than at any time during the previous presidential administration ( )

December 12, 2013 Ed Dolan’s Econ Blog Ed Dolan’s Econ Blog Primary Structural Budget Balance  The broadest measure of the stance of fiscal policy is the primary structural balance (PSB)—the deficit or surplus at all levels of government adjusted for both interest payments and the state of the business cycle  On the downslope of the recession, Bush and Obama stimulus programs moved the PSB toward deficit  The PSB has been moving back toward surplus since the recovery began in mid-2009, showing a trend toward tighter fiscal policy

December 12, 2013 Ed Dolan’s Econ Blog Ed Dolan’s Econ Blog The Output Gap  The economy’s output gap is a useful reference point for evaluating fiscal policy  The output gap is the difference between the actual level of GDP and the level that the economy could produce if it operated at its potential real output  For the U.S. economy, potential real output would correspond to an unemployment rate of about 6 percent

December 12, 2013 Ed Dolan’s Econ Blog Ed Dolan’s Econ Blog Neutral, Countercyclical, and Procyclical Fiscal Policy The relationship between changes in the primary structural balance (PSB) and the output gap over the business cycle defines three types of fiscal policy:  If the PSB is constant over the course of the business cycle, the actual budget will move into deficit when the economy dips into recession and into a larger than normal surplus during a boom. That pattern of policy is cyclically neutral.  A countercyclical fiscal policy attempts to smooth the business cycle by using discretionary tax cuts or spending increases to move the PSB toward deficit during a recession, and by using tax increases and spending cuts to prevent overheating during a boom.  A procyclical fiscal policy amplifies the business cycle rather than smoothing it. It does so by using tax increases and spending cuts to move the PSB toward surplus when the economy is operating below potential and then cutting taxes and increasing spending in times of prosperity.

December 12, 2013 Ed Dolan’s Econ Blog Ed Dolan’s Econ Blog US Fiscal Policy Has Been Procyclical During the Recovery  Since the recovery officially began in mid-2009, US fiscal policy has been strongly procyclical  Although the output gap has been negative, the primary structural balance has moved sharply toward surplus  This procyclical fiscal policy has slowed the recovery from the Great Recession and is projected to continue to slow it

December 12, 2013 Ed Dolan’s Econ Blog Ed Dolan’s Econ Blog The Bottom Line  The Murray-Ryan budget detail changes some details of spending and revenue but leaves the trajectory of current and projected primary structural balances largely unchanged  Because it locks in procyclical fiscal policies, it can be considered a victory for fiscally conservative “deficit hawks.”  The deal is likely to mean that the recovery will continue to be a slow one

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