Chapter 13Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved ECON Designed by Amy McGuire, B-books, Ltd. McEachern 2010-

Chapter 13 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved

ECON

Designed byAmy McGuire, B-books, Ltd.

McEachern 2010-2011

13CHAPTERFederal Budgets and Public Policy

Macro


LO1

The Federal Budget Process

Federal budget– Outlays• Government purchases• Transfer payments– Revenues– Specific period Federal government – shifted focus– From national defense– To redistribution


LO1

Defense’s Share of Federal Outlays Declined Since 1960 and Redistribution Increased

Exhibit 1


LO1

Presidential and Congressional Roles

The President– Budget proposal• Budget request from each agency• “The budget of U.S. government” to

Congress– Council of Economic Advisors• “Economic report of the President” House and Senate– Budget committees: Budget resolution


LO1

Presidential and Congressional Roles

Budget deficit: Outlays > Revenues– Stimulates AD in short run– Reduces national saving– Long run: hinder economic growth Budget surplus: Revenues > Outlays– Dampens AD in short run– Boosts domestic saving– Long run: promote economic growth


LO1

Problems with Federal Budget Process

Continuing resolutions– Instead of budget decisions Lengthy budget process Uncontrollable budget items No separate capital budget Overly detailed budget


LO2

Fiscal Impact of the Federal Deficits

Rationale for deficits– Outlays that increase economy’s

productivity Budget philosophies and deficits– Annually balanced budget– Cyclically balanced budget– Functional finance


LO2


Federal deficits: since birth of the nation– 1789-1930 – Deficit: 33% of years (war)

– Since the Great Depression– Deficit: 85% of years

– 1980s relatively large deficits– Large tax cuts – High defense spending

– 1990s: improved economy– Decreasing deficits– By 1998: surplus


LO2


Federal deficits: since birth of the nation– 2001 recession– Tax cuts– Higher federal spending– Deficits

– Weak recovery– War against terrorism

– 2003, deficit 3.5% of GDP– 2007 stronger economy– Rising stock market– Deficit 1.2% of GDP

– 2009 deficit of $1.8 trillion projected


After Decades of Federal Budget Deficits, Surpluses Appeared from 1998 to 2001, But Deficits Are Back

LO2 Exhibit 2


LO2


Why have deficits persisted?– Tax cuts– Spending increase– Federal officials• Not required to balance the budget– Elected officials• Big spending programs• Small taxes• Pork-barrel spending


LO2


Increase federal deficits– National saving – reduced– Interest rates – higher– Investment• Discouraged (crowding out)• Stimulated (crowding in)


LO2


The twin deficits– Finance huge deficits• U.S. Treasury – sells IOUs• High interest rates• Greater demand for $• U.S. trade deficit increase• Foreigners buy U.S. assets– Increase I– Decline S


During the 1990s, Federal Outlays Declined Relative to GDP and Revenues

Increased, Turning Deficits into Surpluses, But Not for Long

LO2Exhibit 3


The National Debt

LO3

National debt– Net accumulation of past deficits Measuring the national debt– Gross debt• U.S. Treasury notes – by federal agencies– Debt held by the public• U.S. Treasury securities– Households; Firms– Banks (include the Fed)– Foreign entities


Federal Debt Held by the Public as a Percentage of GDP Since 1940

LO3 Exhibit 5


Relative to GDP, U.S. Net Public Debt in 2008 Was Above Average for Major EconomiesLO3Exhibit 6


The National Debt

LO3

Interest on the national debt– Buyers of federal securities• Individuals, $25• Institutions, $1 million• Increasing interest rates• 1 percentage point increase

in nominal interest rate– Interest cost increase $58 billion

per year


The National Debt

LO3

Who bears the burden of debt?– Billing future taxpayers• For current spending– We owe it to ourselves• Future generations– Service the debt– Receive the payments

– Foreign ownership of debt• Increase burden of debt– Future generations of Americans


Foreign Holders of U.S. Treasury Securities

LO3Exhibit 8


The National Debt

LO3

Crowding out and capital formation– Deficit spending, long run– Borrowed funds – invested in

public capital• Increased productivity• Increased standard of living– Borrowed funds – current

expenditures• Less capital formation


The National Debt

LO3

Intergenerational view of deficits and debt

– Welfare of generations• Tied together– Parents now• Consume less• Save more• Reduce the burden on next

generation– Issues• People with no children• Informed of federal spending


LO3

Case

Stu

dy

An Intergenerational View of Deficits and Debt

Barro model assumes parents are concerned

about the welfare of their children, who, in turn,

are concerned about the welfare of their children

and so on for generations.


LO3

Case

Stu

dy Barro: Parents can reduce the

burden of the federal debt on future generations by

consuming less saving more



LO3

Case

Stu

dy As governments substitute deficits for

taxes, parents consume less/save more to increase gifts/bequests to their children.

If greater saving offsets federal deficits, deficit spending will not increase AD because the decline in consumption will negate the fiscal stimulus provided by deficits.

This offsets future burden of higher debt and neutralizes effect of deficit spending on AD, output, and employment.



LO3

Case

Stu

dy Critics:

The evidence fails to support his theory because large federal deficits coincided with lower, not higher, saving rates.

Those with no children may be less concerned about the welfare of future generations.

Theory assumes people are aware of federal spending and tax policies and about the future consequences of current policies.


Documents

Chapter 13Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved ECON Designed by Amy McGuire, B-books, Ltd. McEachern 2010-