31 fiscal policy, monetary policy, and growth blessed are the young, for they shall inherit the...
TRANSCRIPT
31
Fiscal Policy, Monetary Policy, and Growth
Blessed are the young, for they shall
inherit the national debt.HERBERT HOOVER
● Should the Budget Be Balanced? The Short Run
● Surpluses and Deficits: The Long Run
● Deficits and Debt: Terminology and Facts
● Interpreting the Budget Deficit or Surplus
● Bogus Arguments About the Burden of the Debt
● Should the Budget Be Balanced? The Short Run
● Surpluses and Deficits: The Long Run
● Deficits and Debt: Terminology and Facts
● Interpreting the Budget Deficit or Surplus
● Bogus Arguments About the Burden of the Debt
ContentsContents
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● Budget Deficits and Inflation
● Debt, Interest Rates, and Crowding Out
● The True Burden of the National Debt: Slower Growth
● The Economics and Politics of the U.S. Budget Deficit
● Budget Deficits and Inflation
● Debt, Interest Rates, and Crowding Out
● The True Burden of the National Debt: Slower Growth
● The Economics and Politics of the U.S. Budget Deficit
Contents (continued)Contents (continued)
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
● Not always.♦ Attempts to achieve balance during a recession
or an inflationary episode would destabilize the economy.
● Not always.♦ Attempts to achieve balance during a recession
or an inflationary episode would destabilize the economy.
Should the Budget be Balanced? The Short RunShould the Budget be Balanced? The Short Run
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Should the Budget be Balanced? The Short RunShould the Budget be Balanced? The Short Run
● The Importance of the Policy Mix♦ The appropriate fiscal policy depends, among
other things, on the current monetary policy stance.
♦ While a balanced budget may be appropriate under one monetary policy, a deficit or a surplus may be appropriate under another.
● The Importance of the Policy Mix♦ The appropriate fiscal policy depends, among
other things, on the current monetary policy stance.
♦ While a balanced budget may be appropriate under one monetary policy, a deficit or a surplus may be appropriate under another.
FIGURE 31-1 The Interaction of Monetary and Fiscal Policy
FIGURE 31-1 The Interaction of Monetary and Fiscal Policy
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Effect of fiscal policy
Effect of monetary policy
S
S
Y1
D0
D0
Y0
Real GDP
Pri
ce
Le
ve
l
Potential GDP
D1
D1
A
B
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● More expansionary fiscal policy and tighter money supply should produce higher real interest rates and therefore lower investment, slowing economic growth.
● More restrictive fiscal policy and looser monetary policy should reduce real interest rates and hence increase investment and spur economic growth.
● More expansionary fiscal policy and tighter money supply should produce higher real interest rates and therefore lower investment, slowing economic growth.
● More restrictive fiscal policy and looser monetary policy should reduce real interest rates and hence increase investment and spur economic growth.
Surpluses and Deficits: The Long RunSurpluses and Deficits: The Long Run
FIGURE 31-2 Growth and Investment in 24 Countries
FIGURE 31-2 Growth and Investment in 24 Countries
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32 30 28 26 24 22
Japan
Norway Portugal
Finland
Austria
Luxembourg
Italy
Spain
Iceland
Ireland
Canada Greece
Germany France
Australia
Switzerland
New Zealand
Netherlands Sweden
Denmark U.S.
Turkey
Belgium
U.K.
20 18
Average Investment as Percent of GDP, 1970–1990
Ave
rag
e A
nn
ual
Gro
wth
Rat
e o
f p
er
Cap
ita
Rea
l G
DP
, 19
70–
1990
0
1
2
3
4%
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Deficits and Debt: Terminology and FactsDeficits and Debt: Terminology and Facts
● Budget Deficit = excess of a government’s expenditures over its receipts in a period of time♦ A flow
● National Debt = total value of government indebtedness at a moment in time♦ A stock
● Budget Deficit = excess of a government’s expenditures over its receipts in a period of time♦ A flow
● National Debt = total value of government indebtedness at a moment in time♦ A stock
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Deficits and Debt: Terminology and FactsDeficits and Debt: Terminology and Facts
● Some Facts about the National Debt♦ In absolute terms the debt is large, but as a
proportion of GDP it is less than one half.
♦ Some, but not all, is backed by government assets.
♦ Before the 1980s, most of the debt was accumulated in times of war and recession.
● Some Facts about the National Debt♦ In absolute terms the debt is large, but as a
proportion of GDP it is less than one half.
♦ Some, but not all, is backed by government assets.
♦ Before the 1980s, most of the debt was accumulated in times of war and recession.
FIGURE 31-3 The U.S. National Debt Relative to GDP, 1915-2001
FIGURE 31-3 The U.S. National Debt Relative to GDP, 1915-2001
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1915
1993 Budget Agreement
1981–1982 Recession
1981–1984 Tax cuts
1974–1975 Recession
World War II
Great Depression
World War I
1995 1985 1975 1965 1955 1945 1935 1925
1.00
0.67
0.50
Year
Rat
io o
f P
ub
lic
De
bt
to
Gro
ss D
om
esti
c P
rod
uct
0.33
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● Deficit rises in a recession and falls in a boom even with no change in fiscal policy.
● Structural deficit (or surplus) = what the deficit (or surplus) would be at full employment ♦ Portion of the deficit unrelated to the business
cycle♦ Shows how the deficit is related to government
policy
● Deficit rises in a recession and falls in a boom even with no change in fiscal policy.
● Structural deficit (or surplus) = what the deficit (or surplus) would be at full employment ♦ Portion of the deficit unrelated to the business
cycle♦ Shows how the deficit is related to government
policy
Interpreting the Budget Deficit or SurplusInterpreting the Budget Deficit or Surplus
FIGURE 31-4 Official Fiscal-Year Budget Deficits, 1981-2001
FIGURE 31-4 Official Fiscal-Year Budget Deficits, 1981-2001
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’99 ’98 ’97 ’96 ’95 ’94 ’93 ’92 ’91 ’90 ’89 ’88 ’87 ’86 ’85 ’84 ’83 ’82 ’81
’01 ’00
$300
250
200
150
50
–50
100
–250
–200
–150
–100
0
Fed
eral
Bu
dg
et D
efic
it
Fiscal Year
FIGURE 31-5 The Effect of the Economy on the Budget
FIGURE 31-5 The Effect of the Economy on the Budget
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Gross Domestic Product
Sp
end
ing
an
d T
ax R
ecei
pts
Surplus
Deficit
G A
Y3 Y2 Y1
T = Taxes – Transfers
B
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● On-budget Versus Off-budget Surpluses♦ Overall budget surplus = off-budget surplus +
on-budget surplus
♦ Off-budget surplus = revenues – expenditures of off-budget items (primarily Social Security taxes and payments)
♦ On-budget surplus = revenues – expenditures of on-budget items (most other items)
● On-budget Versus Off-budget Surpluses♦ Overall budget surplus = off-budget surplus +
on-budget surplus
♦ Off-budget surplus = revenues – expenditures of off-budget items (primarily Social Security taxes and payments)
♦ On-budget surplus = revenues – expenditures of on-budget items (most other items)
Interpreting the Budget Deficit or SurplusInterpreting the Budget Deficit or Surplus
TABLE 31-1 Alternative Budget Concepts, 1981-2001
TABLE 31-1 Alternative Budget Concepts, 1981-2001
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Bogus Arguments about the Burden of the DebtBogus Arguments about the Burden of the Debt
● Our children will be burdened by high interest payments.
● Repayment of the debt will ruin the nation.
● A nation has a limited capacity to borrow.
● Our children will be burdened by high interest payments.
● Repayment of the debt will ruin the nation.
● A nation has a limited capacity to borrow.
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● Deficits AD♦ Can cause inflation if economy is strong, since
AS curves slope upward
● Deficits AD♦ Can cause inflation if economy is strong, since
AS curves slope upward
Budget Deficits and InflationBudget Deficits and Inflation
FIGURE 31-6 The Inflationary Effects of Deficit Spending
FIGURE 31-6 The Inflationary Effects of Deficit Spending
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Deficit spending boosts aggregate demand
Aggregate supply curve shifts inward as wages rise
Real GDP
S
S
D0
D0
$8,000 $7,000 $6,000 $5,000
112
106
Pri
ce
Le
ve
l
100
D1
D1 Potential GDP
C
B
A
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Budget Deficits and InflationBudget Deficits and Inflation
● The Monetization Issue♦ If the Federal Reserve takes no countervailing
actions, an expansionary fiscal policy that increases the budget deficit will tend to■ real GDP and prices■Cause outward shift of the demand curve for
money interest rates
● The Monetization Issue♦ If the Federal Reserve takes no countervailing
actions, an expansionary fiscal policy that increases the budget deficit will tend to■ real GDP and prices■Cause outward shift of the demand curve for
money interest rates
FIGURE 31-7 Fiscal Expansion and Interest Rates
FIGURE 31-7 Fiscal Expansion and Interest Rates
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S
M
M0
D0
Inte
res
t R
ate
Shift in money demand caused by rising Y and P
For given Fed policy
Quantity of Money
M1
D1
A
B
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Budget Deficits and InflationBudget Deficits and Inflation
● The Monetization Issue♦ If the Fed does not want interest rates to rise
■It can engage in expansionary open-market operations, that is, purchase more government debt.
■The money supply will then increase.■The portion of the deficit purchased by the Fed has
been monetized.
● The Monetization Issue♦ If the Fed does not want interest rates to rise
■It can engage in expansionary open-market operations, that is, purchase more government debt.
■The money supply will then increase.■The portion of the deficit purchased by the Fed has
been monetized.
FIGURE 31-8 Monetization and Interest Rates
FIGURE 31-8 Monetization and Interest Rates
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S0
M0
M0
D0
Inte
rest
Rat
e
Expansionary Fed policy
Quantity of Money
S1
M1
M1
D1
C
B
A
Monetized Deficit SpendingMonetized Deficit Spending
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Real GDP
Expansionary monetary policy
Pri
ce
Lev
el
Expansionary fiscal policy
D 0
D0
D1
D 1
D2
D 2
S
S
AB
C
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● Crowding out♦ Occurs when unemployment is low deficit interest rates investment + capital stock
♦ Investment spending is thus crowded out by government deficit.
● Crowding out♦ Occurs when unemployment is low deficit interest rates investment + capital stock
♦ Investment spending is thus crowded out by government deficit.
Debt, Interest Rates, and Crowding OutDebt, Interest Rates, and Crowding Out
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Debt, Interest Rates, and Crowding OutDebt, Interest Rates, and Crowding Out
● Crowding in♦ Occurs when unemployment is high deficit output savings +
capacity utilization investment + capital stock
● Crowding-in is likely to dominate in the short run, crowding-out in the long run.
● Crowding in♦ Occurs when unemployment is high deficit output savings +
capacity utilization investment + capital stock
● Crowding-in is likely to dominate in the short run, crowding-out in the long run.
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True Burden of the National Debt: Slower GrowthTrue Burden of the National Debt: Slower Growth
● Much of the debt prior to the 1980s was accrued during recessions, when crowding-in probably occurred.
● Since 1980, high deficits have often persisted along with high employment, leading one to think that crowding-out predominated.
● Much of the debt prior to the 1980s was accrued during recessions, when crowding-in probably occurred.
● Since 1980, high deficits have often persisted along with high employment, leading one to think that crowding-out predominated.
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True Burden of the National Debt: Slower GrowthTrue Burden of the National Debt: Slower Growth
● The arguments that a large national debt may lead the nation into bankruptcy, or unduly burden future generations who have to make onerous payments of interest and principal, are mostly bogus.
● The arguments that a large national debt may lead the nation into bankruptcy, or unduly burden future generations who have to make onerous payments of interest and principal, are mostly bogus.
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True Burden of the National Debt: Slower GrowthTrue Burden of the National Debt: Slower Growth
● The national debt will be a burden if ♦ It is sold to foreigners.
♦ It is contracted in a fully employed, peacetime economy.
♦ In the latter case, it will reduce the nation’s capital stock.
● The national debt will be a burden if ♦ It is sold to foreigners.
♦ It is contracted in a fully employed, peacetime economy.
♦ In the latter case, it will reduce the nation’s capital stock.
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True Burden of the National Debt: Slower GrowthTrue Burden of the National Debt: Slower Growth
● Under some circumstances, budget deficits are appropriate for stabilization-policy reasons.
● Until the 1980s, the public debt was mostly contracted as a result of wars and recessions.♦ Precisely the circumstances under which the
valid burden-of-the-debt argument does not apply
● Under some circumstances, budget deficits are appropriate for stabilization-policy reasons.
● Until the 1980s, the public debt was mostly contracted as a result of wars and recessions.♦ Precisely the circumstances under which the
valid burden-of-the-debt argument does not apply
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True Burden of the National Debt: Slower GrowthTrue Burden of the National Debt: Slower Growth
● However, the large deficits of the 1980s and 1990s were not mainly attributable to recessions, and were therefore worrisome.
● However, the large deficits of the 1980s and 1990s were not mainly attributable to recessions, and were therefore worrisome.
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Issue Revisited: Was Fiscal Stimulus Warranted in 2001?Issue Revisited: Was Fiscal Stimulus Warranted in 2001?
● Emergency spending and first phase of tax cut after September 11th attacks stimulated economy.♦ Short-run effects: stimulate AD.
♦ Long-run effects: perhaps crowding out
● Emergency spending and first phase of tax cut after September 11th attacks stimulated economy.♦ Short-run effects: stimulate AD.
♦ Long-run effects: perhaps crowding out
??
FIGURE 31-9 S-R Effect of Larger Deficits or Smaller Surpluses
FIGURE 31-9 S-R Effect of Larger Deficits or Smaller Surpluses
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S
S
Pri
ce L
evel
Real GDP
??
D1
D1
B
D0
D0
A
FIG. 31-10 L-R Effect of Larger Deficits or Smaller Surpluses
FIG. 31-10 L-R Effect of Larger Deficits or Smaller Surpluses
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Potential GDP
Y1 Y0
Pri
ce
Le
ve
l
Real GDP
??
D
D
S1
S1
S0
S0
A
B
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The Economics and Politics of the U.S. Budget DeficitThe Economics and Politics of the U.S. Budget Deficit
● The deficits of the early 1980s came during recessions and hence crowding out was not a serious problem.
● By 1987 the economy was approaching full employment and hence crowding out was becoming a problem.
● The deficits of the early 1980s came during recessions and hence crowding out was not a serious problem.
● By 1987 the economy was approaching full employment and hence crowding out was becoming a problem.
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The Economics and Politics of the U.S. Budget DeficitThe Economics and Politics of the U.S. Budget Deficit
● Deficit was eliminated by ♦ raising taxes and
♦ reducing spending;
♦ an expanding economy also produced more tax revenues.
● Deficit was eliminated by ♦ raising taxes and
♦ reducing spending;
♦ an expanding economy also produced more tax revenues.