THE DEFICIT AND THE DEBT

What is the current national debt?Debt ClockTwo primary tools of discretionary fiscal policy:• spending (G)• taxes (T)

THE DEFICIT AND THE DEBT

When government conducts expansionary fiscal policy to counteract recession, spending (G) increases and/or taxes (T) decrease.

EXPANSIONARY FISCAL POLICY

When the government conducts contractionary fiscal policy to alleviate inflationary pressures, governments spending (G) decreases and/or taxes (T) increases.

CONTRACTIONARY FISCAL POLICY

• When G =T, government has balanced budget

• When G increases and/or T decreases, government budget moves toward deficit

• Deficit occurs when government spends more than it collects in taxes and borrows to cover the difference; G › T.

• This is done by issuing bonds.

BUDGET DEFICIT

• The sum of all past deficits is the debt.

• A budget deficit results in an increase in the demand for loanable funds.

BUDGET DEFICIT

• When T › G, there is a budget surplus.

• A budget surplus reduces the demand for loanable funds.

• If government pays off debt, there is an increase in loanable funds.

BUDGET SURPLUS

LOANABLE FUNDS MARKET

Q loanable funds

S

D + (G-T)D

RealInt.rate

i1

I1

i

I and i are initial equilibrium valuesD=private sector demand for funds (investment).D+(G-T)=private + gov. demand for funds.

I1 and i1 are the new equilibrium ValuesI2=new level of private investment

I1-I2 = government demand for funds

(G-T)

II2

Crowding out refers to the decrease investment and consumption that occurs when the government’s demand for loanable funds causes the interest rate to rise.The demand by government for loanable funds decreases or crowds out the private demand for loanable funds.

CROWDING OUT

• From whom does the government borrow money to cover its debt?

Individuals

Institutions

Other gov. agencies

If you want to learn more, check out the

Bureau of the Public Debt. You can browse all sorts of fiscal policy data.

CROWDING OUT

What are some of the lags associated with policy making?Inside lags: • Time for collecting data• Time for policy makers to

recognize that policy action is necessary

• Deciding which policy should be undertaken

• Time to implement the policy

CROWDING OUT

Outside lag:• Time for the economy to

respond to the policy

• The lags differ in time for monetary and fiscal policy

• Complete activity 5-7

CROWDING OUT

CROWDING OUT