The Budget Balance
Government savings is defined by the following equation:
T: Tax Revenues
G: Government purchases of goods & services
TR: Government transfers
As a rule of thumb, expansionary fiscal policies server to reduce the budget balance (ie. decrease budget surplus or increases budget deficit)
increase government spending
increase transfer payments
Generally, contractionary fiscal policies will increase the budget balance (ie. increase budget surplus or decrease budget deficit)
decrease government spending
decrease transfer payments
Cyclically Adjusted Budget Balance
An estimate of what the budget balance would be if real GDP were exactly equal to potential output
Government tax revenue tends to rise and government transfers fall during economic expansions. Budget tend towards a surplus
Conversely, tax receipts decrease and government transfers increase during contractions. Budget tend towards a deficit
Should the Budget Be Balanced
This is a normative question!
A balanced budget amendment nearly passed through Congress to be sent to the states for ratification in 1994, falling 4 votes short of the 2/3rd Senators necessary (63-67)
A good number of economists would argue against an amendment as that would restrict a country's ability to run a budget deficit during recessions. Recessions would be worsened!
However, when large deficits persist year after year, the national debt grows and grows and grows and grows…
The National Debt in February 2014 ~$17.3 trillion
Problems of a Rising Government Debt
"Crowding out" effect
When the government borrows funds in the financial markets, it competes with private firms and "crowds out" private spending by raising interests rates and reducing long-run economic growth
Today's deficits increase the public debt and so puts financial strains on future budgets
Like a consumer maxed out on credit cards, a government with rising amount of debt may eventually default on payment
In 2001, Argentia defaulted on its payments and caused havoc in the country's economy and a serve recession
So why not print money to pay off the debt??
Trends in Debt-GDP Ratio
During times of war, the US has trended towards runing a budget deficit
During World War II, the government ran up a huge deficit, and so the US Debt-GDP ratio was over 100% at its peak
In 2012, during "relative" peace, the US Total Debt-GDP ratio exceeded 100%
With projected budget deficits to continue, the debt will continue to get larger and larger
Some troubled countries in 2013
Greece 173% Debt-GDP ratio
Japan 140% Debt-GDP ratio
Spending promises made by the government but not included in the actual debt totals
Three largest implicit liabilities of the American Government
If included in the national debt, the $17.3 trillion figure (Feb 2014) would actually much higher
If the government prepared its financial reports the way private companies do, the net present value of all debt would be closer to $100 trillion!
Drawn an AD-AS graph an economy in a recession. What will happen if the government increase taxes and decreases spending to reduce the deficit and lower the national debt?
If government spending exceeds tax revenues which of the following is necessarily true?
a. Positive budget balance
b. Budget deficit
Which of the following fiscal policies is contractionary
a. Increasing taxes by $100 billion and increasing spending by $100 billion
b. Decreasing taxes by $100 billion and Decreasing spending by $100 billion
c. Increasing taxes by $100 billion and decreasing spending by $100 billion
d. Decreasing taxes by $100 billion and increasing spending by $100 billion
e. None of the above
Which of the following is reason to be concerned about perpetural beget deficits?
a. Crowding out
b. Government default
c. The opportunity cost of future interest payments
d. Higher interest rates leading to decrease long-run growth
e. All the above