KRUGMAN'S MACROECONOMICS for AP* 30 Margaret Ray and David Anderson Module Long-run Implications of Fiscal Policy: Deficits and the Public Debt

What you will learn in this Module : Why governments calculate the cyclically adjusted budget balance Why a large public debt may be a cause for concern Why implicit liabilities of the government are also a cause for concern

Deficits Surpluses Good? Bad? The Budget Balance

The Budget Balance as a Measure of Fiscal Policy The Budget Balance as a Measure of Fiscal Policy S gov = T - G - Transfers Expansionary policies reduce budget balance Contractionary policies increase budget balance G has a greater impact than T or Transfers Changes in budget balance are often result, not cause, of economic fluctuations

The Business Cycle and the Cyclically Adjusted Budget Balance Strong relationship between budget balance and business cycle

Cyclically adjusted budget balance The Business Cycle and the Cyclically Adjusted Budget Balance (Continued)

Should the Budget Be Balanced? Should the Budget Be Balanced? Political motivation for running deficits or balancing the budget (deficits cater to voters) Economists argue against balanced budget rule in favor of cyclically balanced budget (automatic stabilizers would be compromised) Limits on deficits as a compromise

Deficits, Surpluses, and Debt Deficits, Surpluses, and Debt When spending exceeds tax revenue, government borrows (crowding out threatens investment) (increasing payment to interest threatens future budgets) Fiscal years Public Debt

Problems Posed by Rising Government Debt Problems Posed by Rising Government Debt Government competes with private sector for investment funds Financial pressure on future budgets Possibility of Default Monetizing the Debt (issuing of T-bonds) Cyclical budget

Deficits and Debt in Practice Deficits and Debt in Practice Debt-GDP Ratio

Implicit Liabilities Implicit Liabilities Implicit Liabilities (spending promises made by the gov, not included in debt statistics) Social Security Demographics (Baby boomers retiring—stop paying taxes and start collecting beneftis) Medicare Medicaid

Module Monetary Policy and the Interest Rate KRUGMAN'S MACROECONOMICS for AP* 31 Margaret Ray and David Anderson

What you will learn in this Module : How the Federal Reserve implements monetary policy, moving the interest rate to affect aggregate output Why monetary policy is the main tool for stabilizing the economy

Monetary Policy and the Interest Rate: Targeting the Fed Funds Rate

Expansionary Monetary Policy Expansionary Monetary Policy The Economy The Money Market 1) Open Market purchase 2) Lowers the interest rate 3) Which increases demand for money for investment

Contractionary Monetary Policy Contractionary Monetary Policy The Economy The Money Market 1) Open Market salse 2) increases the interest rate 3) Which decreases demand for money for investment

Monetary Policy in Practice Fed policy and the output gap Taylor Rule (setting the Fed Funds Rate that takes into account both inflation rate and output gap) Fed Funds Rate = 1 + (1.5 x inflation rate) + (0.5 x output gap) OR 1+(1.5 X π%)+(0.5 X Output Gap) Stanford Economist, John Taylor

Inflation Targeting Inflation Targeting The Fed and Inflation (prefers inflation of about 2%) Inflation Targeting (used by “other” central banks— more accountability and transparency—everyone knows the goal and if the bank doesn’t succeed, it comes under scrutiny) Inflation Targeting v. Taylor Rule (Infl Targ more forward-looking than backward-looking as the Taylor Rule) Inflation Targeting v. Fed discretion