Chapter 19. Government Debt and Deficits

Had been chapters 15 or 16 in earlier editions.

No homework!!

Table 19-1, p. 545

Fig. 19-1, p. 549. The Ratio of Government Debt to GDP since 1790.

Future Demands on the Federal Deficit. (Different text)

mt believes it is irresponsible to include 80 year projections,because so much can and will change.

Ownership of the U.S. Public Debt, 2005

Other text

US deficits, 1930-2010U.S. Gov't. Surplus or

Deficit(−)/GDP

-7.0-6.0-5.0-4.0-3.0-2.0-1.00.01.02.03.04.05.0

1930 1940 1950 1960 1970 1980 1990 2000 2010

Surplus or Deficit(−)

Data from U.S. CBO

Review of Deficit/Debt, by Presidents

For a long time, balanced budget was the goal. This was changed by Roosevelt, and re-enforced by Kennedy/Johnson

The deficit grew dramatically under Reagan. This was caused byhis tax cuts, defense spending, and the contractionary policiesof the Federal Reserve Bank.

Under Clinton, the deficit was turned into a surplus. Perhaps thiswas due to good policies. Republicans would claim that it wasdue to their not letting him spend in areas like Health Care.

A major contributor to the non-re-election of George H Bush was his promise of “No new taxes.”

Old figure 19.3

TM-128

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All RightsReserved.

Federal Budget Deficits and Surpluses, Actual and Projected, Fiscal Years 1990-2010

Old-Figure 18.3

The view as of 1999: Clinton had moved from a deficit to a surplus.

P. 382Bade/Parkin

The Bush Plans for a Tax Cut Package ~ 2000

Surpluses “as far as the eye can see,” financing tax refunds.

Why did the Clinton’s government surplus turn into deficit under President Bush?

1. Economic slowdown (39%) 9-11 Bubble economy—Enron, World.com, Increasing competition from overseas producers

2. Tax cuts (27%)

3. Greater spending on Iraq, Homeland security (19%)

4. Others (15%)

Analysis according to Henry Aaron (Brookings Inst.)

Source: http://www.brookings.edu/dybdocroot/views/testimony/aaron/20040204.pdf

White House and CBO’s Deficit Projections in 2009

Source: Washington Post March 21, 2009

The major point is the dramatic increase in the deficit in 2009.

Source: New York Times, Feb. 27, 2009

The View in Late 2012 Background to the talks on the “Fiscal Cliff” (“playing chicken”):

a. Tax revenues decline in a recession b. The actual dollar amounts of recent major bail-outs will not be known for a while, until all the accounting is in c. Current debates about the US deficit confuse the problems from the current (post-2008) bailout with the long term structural problems relating to social security and health care.

Obama’s victory removed chances of the proposals pushed by Romney; reduce taxes – especially don’t increase taxes on the rich, along with his idea that the budget can be significantly altered by filling tax loopholes, while further weakening of the social safety net, Social Sec. and Medicare.

Gramm Rudman Hollings Act, 1985 (and revisions)Set up a multi-year schedule of targets for reduction of gov’t deficits.

If the deficit didn’t meet the targets, there would be automatic cuts - ‘sequesters’ - and these automatic cuts would not touch defense nor Social Security.

Was declared unconstitutional by the Supreme Court, as it gave somebody (the computer programmer for the Congressional Budget Office) power over both the Legislative and the Executive branches.Also, Congress ignored rules during wars and emergencies.

Importance: Seemed to be the last chance at forcing balanced budgets by legislation, short of a constitutional amendment.Rudman to Congress: I’m filing for divorce on the grounds of infidelity and irreconcilable differences.

Fig. 3-9 p. 72. A Reduction in Saving due to Higher Gov’t Spending: Classic Loanable Funds

Classic assumes full employment, loanable funds, closed economy,. Complete crowding out – via investments. No change in AD nor prices.

(Also, see Ricardian equivalence, below).

Figure 5-3. P. 129. Fiscal Expansion in a Small Open Economy

Classic assuming full employment, loanable funds, open economy. Complete crowding out – via net exports. No change in AD nor prices.

Fig. 12-1, p. 329. An Increase in Government Purchases in Closed Economy IS-LM

Basic IS-LM, closed economy, not full employment. In short run, incomplete crowding out, and AD moves. With a vertical LRAS, eventually complete crowding out, via investments, with prices rising.

Fig. 13-4, p. 362. Fiscal Expansion Under Floating Exchange Rates: Mundell-Fleming

Complete crowding out, via net exports. No assumption of full employment. No change in AD.

Fig. 13.17 p. 393. Fiscal Expansion in a Large Open Economy

Incomplete crowding out, reducing investments and net exports.AD moves right: Real GDP increases in short run. (Not covered, F 2014)

Fig. 10-13, p. 295. An Increase in AD

New SRAS

Rational expectations school claims that an announced expansionary policy – increasing AD - will lead to an immediate upward shift in SRAS. No change in output. The increased prices reduce investment.

The Laffer Curve. Not even mentioned by Mankiw, buthinted at on page 312?. Made a brief comeback in U.S. politics

(mid-2011).

(Different Textbook)

Laffer Range

Traditional Range

In the ‘Laffer range’ cutting tax rates will lead to balancing the budget.

Robert Barro, 1944-

Link to article on tax reform

http://post.economics.harvard.edu/faculty/barro/bw/bw05_01_24.pdf

Ricardian equivalence,Economic growth

B.S. in Physics, Cal Tech 1965Harvard Ph.D. Has taught at Chicago, Brown, MITNow at Harvard.

Ricardian Equivalence (19-4, pp. 554-58)

The idea that government debt does not influence national saving,nor, therefore capital accumulation, nor AD. No crowding out.

Forward looking consumers foresee having to save to pay taxes for the debt, so an increase in government spending today will be offset by a decrease in consumption today.

Limited by consumer myopia, borrowing constraints.

Deficits: Actual and forecast

New York Times, July, 2004

Deficit under George W. Bush

When W. was elected, the projections were for surpluses “as far as the eye can see”

As a candidate, W. promised tax cuts, and implemented one quickly after entering office, mailing tax refunds to citizens.

The majority of economists would probably agree that the overall impact of W.’s tax cuts has been regressive, i.e. lowering taxes more for the very wealthy.

Comments on Bush’s 2005 Budget1. Projected to decline… but does not include spending on Iraq, Homeland Security.2. Several controversial aspects are future tax cuts, or making permanent future tax cuts3. Does not incorporate radical supply side predictions, as in Laffer curve4. Does not confront longer term deficits in social security

5. “Full employment budget” logic would make deficits smaller

6. Sense that many, especially anti-government supply-siders, are willing to “play chicken” – force down tax revenues, and then force down spending.

Presidential Budgets

Source: earlier edition of McConnell/Brue Textbook

Surplus/Deficit/GDP, 2000-2050

Projected long term impact of social security.

Why did Clinton’s surplus turn into deficit under W?

1. Economic slowdown (39%) 9-11 Bubble economy—Enron, World.com, Increasing competition from overseas producers

2. Tax cuts (27%)

3. Greater spending on Iraq, Homeland security (19%)

4. Others (15%)

Analysis according to Henry Aaron (Brookings Inst.)

Source: http://www.brookings.edu/dybdocroot/views/testi mony/aaron/20040204.pdf