DeficitsDeficits, SurplusesSurpluses and the Public DebtPublic Debt

Budget Deficits and the Public DebtBudget Deficits and the Public DebtChapter ObjectivesChapter Objectives1. Explain the difference between the budget deficit and public debtdifference between the budget deficit and public debt.2. Explain each of the three budget philosophiesthree budget philosophies. A. Annually balanced budget B. Cyclically balanced budget, and C. Functional Finance3. Identify the principal causes of the public debtprincipal causes of the public debt. A. Wartime financing B. Fighting recessions C. Tax cuts D. Lack of political will4. Describe the annual interest chargesannual interest charges on the debt, who holds the debt and the impact of accounting and inflation on the debt.5. State the absolute sizeabsolute size of the debt and the relative sizerelative size as a % of GDP.6. Explain why the debt can also be considered public creditpublic credit.7. Identify and explain two widely held mythstwo widely held myths about the public. A. Going bankrupt B. Burden on our grandchildren8. Explain the effect of the debt on income distributioneffect of the debt on income distribution and Ig.9. Explain how the debt debt [& higher interest rates] might decrease net exportsdecrease net exports.10. Explain 3 proposed remedies to reduce or to eliminate budget deficits3 proposed remedies to reduce or to eliminate budget deficits.

DeficitsDeficits, , SurplusesSurpluses, , and theand the PPublicublic D Debtebt

““Guns”Guns” oror “Butter”“Butter”[Iraq is costing $4 billion a month][Iraq is costing $4 billion a month]

The The ““DebtDebt”” and The and The “Deficit“Deficit””FlowFlow

($412 bil.) StockStock($7.7 trillion)

Reasons for DebtReasons for Debt1. Lack of political will2. Tax cuts3. Recessions (transfers)4. Wartime financing

Attention DeficitAttention DeficitDisorder [ADD]Disorder [ADD]Congressmen have Congressmen have trouble focusing trouble focusing attention attention on theon the deficit. deficit.

$7.4

National Debt Clock

8$24,000

National Debt ClockNational Debt Clock

$7.7$7.7$26,200$26,200

National DebtNational Debt7.7

$33,000 per second is added to the National Debt$33,000 per second is added to the National Debt

3 3, and $4 mil per minuteand $4 mil per minute.or $1.3 Billion per dayor $1.3 Billion per day

$123,000$123,000

$24,500$24,500

The Public Debt Since 1970The Public Debt Since 1970

Sources of Government RevenueSources of Government Revenue 18631863

Sources of Government Revenue-TodaySources of Government Revenue-Today

Three major sourcesof federal taxes(90%) a. Individual income taxes b. Social Insurance c. Corporate income taxes

2005 Federal Budget - $2.57 Tril.2005 Federal Budget - $2.57 Tril.Agriculture 19.4 Interest 211Interest 211[8[8%%]]Commerce 9.4Defense 419.3Education 56.0Energy 23.4Health/Human SVC 67.2Homeland Security 34.2Housing/Urban Dev. 28.5Interior 10.6Justice 20.3Labor 11.5NASA 15.5SEC & Exc Com. 8.5State 32.7Transportation 57.5Treasury 11.6Veteran’s Affairs 33.4

DEFICITSDEFICITS,, SURPLUSES SURPLUSES,, ANDAND DEBTDEBTDefinitions:Definitions:•Budget Deficit [ G>G>TT]•Budget Surplus [ T>G]•National or Public Debt•U.S. Securities

Budget PhilosophiesBudget Philosophies•Annually Balanced Budget•Cyclically Balanced Budget•Functional Finance

[$14,300[$4,850-dependent][$7,150-single]

35%

33%

28%

25%

15%

10%

Standard Deduction$10,200

$7,150 $29,050$70,350 $146,750 $319,100$14,300

ProportionalProportional & & RegressiveRegressive Taxes Taxes

Think of your income as a Think of your income as a LLaayyeerr CCaakkee..The 11stst layer layer will not be taxed at all. ($7,150$7,150 for singles)In the 22ndnd layer layer, taxable income starts at 10% up to $14,35010% up to $14,350.The 33rdrd layer layer starts at 15% up to $29,05015% up to $29,050.The 4rth layer4rth layer starts at 25% up to $70,35025% up to $70,350.The 55thth layer layer starts at 28% up to $146,75028% up to $146,750.The 66thth layer layer starts at 33% up to $319,10033% up to $319,100.The 77thth layer layer starts at 35% for those over $319,10035% for those over $319,100.With a tax cut, high earners not only get a tax cut on With a tax cut, high earners not only get a tax cut on the top layer but all layers.the top layer but all layers.

Our Progressive Tax System Is Like A LLaayyeerreedd CCaakkee

35% over $319,100

No tax on 1st $7,150

10% up to $14,350

15% up to $29,050

25% up to $70,350

28% up to $146,75033% up to 319,100

State, City, and County Sales TaxState, City, and County Sales Tax

The Seven States With No Income TaxThe Seven States With No Income Tax

By relying on regressiveregressive sales, property, & excise taxes, Texas is taxing its poor more than five times the rate it does the rich. Texas has one of the most regressiveregressive tax systems. Texas does notdoes not have a state income tax.

7.67.64.24.2 3.33.3 3.03.0 2.92.9 2.52.5 1.51.5

6.86.8

5.05.04.04.0 3.53.5 2.92.9 2.32.3

1.51.5

2.72.7

1.51.11.1

0.90.9

20%20%18%18%16%16%14%14%12%12%10%10% 8%8% 6%6% 4%4% 2%2% 00

Excise TaxExcise TaxSales TaxSales TaxProperty TaxProperty Tax

$10,812 $23,100 $35,300 $51,400 $80,400 $180,000 $945,500$10,812 $23,100 $35,300 $51,400 $80,400 $180,000 $945,500

Average Annual IncomeAverage Annual Income

$1,812 2,472 2,965 3,804 5,470 9,180 29,311$1,812 2,472 2,965 3,804 5,470 9,180 29,311

17.117.1%%

10.710.7%%

8.48.4%% 7.47.4%%6.46.4%% 5.15.1%%

3.13.1%%

Percentage of income of a family of four in state/local taxes (Texas)Percentage of income of a family of four in state/local taxes (Texas)

31. Texas gets most of its revenue from the sales tax.

Texas Tax Revenue By SourceTexas Tax Revenue By Source

Sales Tax Sales Tax (R)(R)60%60%

Motor FuelsMotor Fuels11% 11% (R)(R)

Motor VehicleMotor Vehicle8% 8% (R)(R)

FranchiseFranchiseTax 4% Tax 4%

Natural Natural Gas 4%Gas 4%

OilOil4%4%

Mostly Mostly RegressiveRegressive

Estate TaxEstate Tax

20012001Surplus ofSurplus of$127 bil.$127 bil.

Causes:• Wars• RecessionsRecessions• Tax Cuts

THE PUBLIC DEBTTHE PUBLIC DEBTFacts & Figures:

Quantitative Aspects

• Debt and GDP• International Comparisons• Interest Charges• Ownership

FFinancial inancial Price Price Of Of WarWarTotal Total CCost ost pperer

ConflictConflict CostCost PersonPersonWW1 $125 bil. $2,489WWII$600 bil. 20,388Korea 336 bil. 2,266Vietnam 494 bil. 2,204Gulf War I 76 bil. 306Gulf War II 144 bil.** 536** Cost over $4 bil. a month

Changes in Marginal Tax RatesChanges in Marginal Tax Rates

200020001990199019801980197019701960196019501950194019401930193019201920

Top tax rate, in percentTop tax rate, in percent100%100%

8080

6060

4040

2020

00

35%35%

Medicare Tax(1.45%)

Medicare tax – 1.45% for an individual [2.9% for self employed] for every dollar earned.

Harrison Ford – received $25 million for 20 days work on

a movie. 1.45% of $25 million = $362,500 x 2 = $725,000 medicare tax.[Over his 35 years on the Big Screen, his films grossed over $10 billion. J im Carrey – gets $20 million per movie, so his tax is

$580,000. [1.45% of $20 million = $290,000 x 2 = $580,000.]

Tax Rate, in %

Top Marginal Tax Rates Year Tax Rate 1900 No Tax 1914 1%[over $3,000] [Only 1 in 270 paid this tax at all] 1930 30% [1 in every 32 was now paying taxes] 1940 81% [1 in every 3 was paying taxes] 1943 *Paycheck withholding(by the boss) was launched to stop cheating. 1950 91% 1970 70% [Everyone was paying with taxable Y] 1980 70% 2002 38.6%

Tax Rate 1913-2000

2005 35%2005 35%

Nation’s Nation’s Wealthiest 5Wealthiest 5% % Pay Pay 5555%% of of Income TaxesIncome Taxes

Ave. Tax RateAve. Tax RateTop Top 11% ($293,000) paid over 1/3 of all taxes – average 28%% ($293,000) paid over 1/3 of all taxes – average 28%

Top Top 55% (+ $121,000; 6.3 mil.) paid 55% - average 24%% (+ $121,000; 6.3 mil.) paid 55% - average 24%

Top Top 1010% (+80,000) paid 62% of all taxes – average 21.4%% (+80,000) paid 62% of all taxes – average 21.4%

Top Top 2525% (+$50,000) paid 81% of all taxes – average 18%% (+$50,000) paid 81% of all taxes – average 18%

Top Top 5050% (+$25,000) paid 96% of all taxes – average 16%% (+$25,000) paid 96% of all taxes – average 16%

Bottom Bottom 5050% (63 % (63 mil.mil. earned -$23,000) paid o earned -$23,000) paid onlynly 4 4% of all% of all taxes. taxes.There There are are 3.8 million millionaires3.8 million millionaires & & 341 billionaires341 billionaires..[691 in world][691 in world]40 millionaires are in the U.S. Senate40 millionaires are in the U.S. Senate

Billionaires of the World in 2003Billionaires of the World in 2003

[The U.S. has 50%][The U.S. has 50%]

691 in 2004691 in 2004Worth 2.2 TWorth 2.2 T[341 in U.S.][341 in U.S.]

Of The 100 Million With Of The 100 Million With Full Time Employment:Full Time Employment:

1. Only 5.7%5.7% make above $100,000$100,000

2. 2. 10%10% make between $65,000 & $100,000$65,000 & $100,000

3. 3. 84%84% earn under $65,000$65,000

4. 4. More than halfMore than half earn less than $35,000less than $35,0005. One in four workers(28 M workers) earns $18,800 a year or less, with few if any benefits

““The mass of men lead lives of quiet desperation.”The mass of men lead lives of quiet desperation.” Henry David ThoreauHenry David Thoreau

Highways [.20 a gallon]

STATE ANDSTATE AND LOCAL FINANCE LOCAL FINANCE

State ExpendituresEducationPublic WelfareHealth and Hospitals Public Safety

Education36%

Health &Hospitals

8%Public

Welfare25%Public Safety

5%All Other

18%

Highways8%

Federal ExpendituresFederal Expenditures

Pensions and Income SecurityNational DefenseHealthInterest on Public Debt

Pensions &Income Security

38% NationalDefense

17%

Health21%

All Other15%

Interest13%

2002 Data

TotalExpenditures$2,011 Billion

Federal Tax RevenuesFederal Tax Revenues

PersonalIncome Tax

46%

Personal Income Tax•Marginal Tax Rate•Average Tax Rate

2002 Data

Federal Tax RevenuesFederal Tax Revenues

PersonalIncome Tax

46%

PayrollTaxes38%Corporate

Income Tax8%

All Other4%

Excise Taxes4%

Personal Income TaxPayroll TaxCorporate Income TaxesExcise Taxes

2002 Data

TotalTax Revenues$1,853 Billion

Property Taxes & Other TaxesLicenses and Others

STATE STATE AND LOCAL FINANCEAND LOCAL FINANCE

State Revenues

Corporate Income Tax

Sales and Excise TaxPersonal Income Tax

Sales &Excise Taxes

48%Personal

Income Tax34%

CorporateIncome Tax

7%Licenses & Others

6%

Property Taxes& Other Taxes

5%

STATE AND LOCAL FINANCESTATE AND LOCAL FINANCE

Local Revenues

Property Taxes74%

Personal & CorporateIncome Taxes

6%All Other

4%

Sales &ExciseTaxes16%

Personal & Corporate Income Taxes

Sales and Excise TaxesProperty Taxes

DEFICITS AND SURPLUSESDEFICITS AND SURPLUSES1992 - 20121992 - 2012

Source: Congressional Budget Office

$800

700

600

500

400

300

200

100

0

-100

-200

-300

Bu

dge

t D

efic

its

or S

urp

luse

s, B

illi

ons

1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

ActualActual($412 in 2004)($412 in 2004)

0 20 40 60 80 100 120 140JapanItaly

BelgiumCanadaFranceSpain

SwedenGermany

United StatesNetherlands

United KingdomFinland

DenmarkAustralia

GLOBAL PERSPECTIVEGLOBAL PERSPECTIVEPublic Sector Debt as a percent of GDP, 2002

Source: Organization for Economic Cooperation and Development

Debt Debt and and DeficitDeficit Statistics Statistics

2005 7700.0 11,000.0 265.0 65% 3.6% 26,100

171.0

PUBLIC DEBT OWNERSHIP, 2004

10%

33%

11%

18%

11%17%

Debt heldBy FederalReserve &

GovernmentAgencies

Debt heldOutside the

FederalReserve &

GovernmentAgencies

Federal Reserve

U.S.Government

Agencies

Other, IncludingState & Local Governments

U.S. Banks & FinancialInstitutions

ForeignOwnership

U.S. Individuals

Foreigners hold $1.9 Tril.Japan-$720 B, China-$175 B,Britain-$135 B, OPEC-$44 B, S. Korea-$67 B, H. Kong –$50 B, Taiwan-$57 B, Singapore-$24 B, Thailand-$13 B, & India-$13 B.

ADAD11

BalancingBalancing the the BudgetBudget – during – during RecessionRecession[Increase T [Increase T or or Decrease GDecrease G - - ProcyclicalProcyclical

ASAS

PLPL11

PLPL22

YYRR YY**

PLPL33

YYRR

So, the fiscal actionsto balance the budgetdecreasesdecreases, rather than

increasesincreases ADAD, and isprocyclicalprocyclical, not countercounter.

ADAD33

ADAD22

CutCut

ADAD11

Balancing Balancing the the Budget - Budget - during during InflationInflation[Decrease T or Increase G - [Decrease T or Increase G - ProcyclicalProcyclical]]

ASAS

PL1

PL3

YY** YYIIYYII

PLPL22So, the fiscal actionsto balance the budget

increaseincrease, ratherthan decrease decrease ADAD,& is also procyclicalprocyclical,rather than countecounter.

ADAD33ADAD22

3 Budget Philosophies3 Budget Philosophies[A. Annually Balanced; B. Cyclically Balanced; Functional Finance][A. Annually Balanced; B. Cyclically Balanced; Functional Finance]

EconomyEconomy

Annually Balanced BudgetAnnually Balanced Budget – each time the earth orbits the sunearth orbits the sun weshould balance the budgetbalance the budget.

This would put the G in an economic straitjacketeconomic straitjacket as we couldn’t fight

recessions with deficit spending. This would be like pouring water on pouring water on a drowning man. a drowning man. We used to worship at the alter of a balancedworship at the alter of a balancedbudget budget prior to the Great Depression. 49 states require this.

Balancing the budget during a recession would not be counter-cyclicalnot be counter-cyclical, but pro-cyclicalpro-cyclical. Increasing taxesIncreasing taxes during a recession would worsen theworsen the

recessionrecession. Running aRunning a surplus during boomsurplus during boom times times and giving the giving the money back would be inflationarymoney back would be inflationary.

““Earth Orbits Sun”Earth Orbits Sun”

2. Cyclically Balanced BudgetCyclically Balanced Budget

RecessionRecession““Tax cut”Tax cut”

InflationInflation““Raise taxes”Raise taxes”

Cyclically Balanced BudgetCyclically Balanced Budget – run deficits during recessionsdeficits during recessions &

surpluses during expansionssurpluses during expansions so the budget is balanced not each yearbut over the course of the business cyclecourse of the business cycle. Economic wisdom tells us we should have deficits in lean yearsdeficits in lean years and surpluses in fat yearssurpluses in fat years. There is nothing “sacred about 12 months asnothing “sacred about 12 months as an accounting period.”The government could conduct counter-cyclical fiscal policycounter-cyclical fiscal policy and balance balance Its budget over a period of yearsIts budget over a period of years. The basic problem of this philosophy isthat fluctuations are not usually symmetrical enough to ensure that thesurplus will offset the deficit.

““DeficitDeficit Spending”Spending” ““Balanced”Balanced”

Tax Tax CutsCuts

RaiseRaiseTaxesTaxes

Functional FinanceFunctional Finance – balance the economy not the budget.The annual or cyclically balanced budget is of secondary importancebalanced budget is of secondary importance. Theimportant thing is to provideprovide for non-inflationary, FE for non-inflationary, FE & ensure the economyproduces its potential GDP. If there are chronic deficitsdeficits or surplusessurpluses, so be it.Deficits are minor problemsDeficits are minor problems, compared to inflationinflation or recessionsrecessions.

3.3. Functional FinanceFunctional Finance

““Balance the economy, not the budget.”Balance the economy, not the budget.”

U.S.U.S.EconomyEconomy

• Income Distribution [the debt is transferred from all

taxpayers to the bond holders [the rich], so more income disparity]

• Incentives – larger taxes dampen incentives to bear risk,

to innovate, to invest, or just to work.

• *Children will not inherit as large of a “national factory”

• Foreign-Owned Public Debt

•External Public Debt

Economic Issues FEconomic Issues From rom TThe he DebtDebt

Abe Lincoln, with the Debt at $1 billion in 1864, said, “Men can readily perceive that they cannot be much oppressed by a debt which they owe themselves.”

The “no”“no” answer entails three pointsentails three points.1. RefinancingRefinancing – as portions of the debt fall due each month, the G does not cut G or raise T to retire the maturing bonds. It refinances the debtrefinances the debt by selling new bonds and uses the proceeds to pay off holders of the maturing bonds.2. 2. TaxationTaxation – if bankruptcy were imminent the G could always raise taxes.3. Creating MoneyCreating Money – bankruptcy could be avaided by printing the money (inflationaryinflationary).

I’m not paying no $26,100 and I hope you will not either.

Economic Implications of the Debt: False IssuesEconomic Implications of the Debt: False Issues[The “G”“G” doesn’t have to pay the entire debt off because it never “dies.”“dies.”][The “G”“G” will live foreever so it will keeep “rolling it over in perpetuity”“rolling it over in perpetuity”]

Going Bankrupt?Going Bankrupt?

Shifting BurdensShifting Burdens Does every new born get slapped on the backside, then told he owes $26,100owes $26,100?Not quite. About 82% of the debt is owed to ourselves82% of the debt is owed to ourselves. Thus the public debt is apublic debt is aa public credita public credit. It is a liability to the taxpayerliability to the taxpayer but an asset to the peopleasset to the people (bondholdersbondholders). Therefore, retiring the debt would amount to a large transfer paymentretiring the debt would amount to a large transfer payment from U.S. U.S. citizens to U.S. citizenscitizens to U.S. citizens. The repayment would entail no decrease in the economy’swealth or standard of living. So the babies who inherit $26,100 worth of debt willbabies who inherit $26,100 worth of debt willinherit almost that same amountinherit almost that same amount.

Whew! $26,100 each.Whew! $26,100 each.

IIDD

Investment (billions of dollars)

Rea

l in

tere

st r

ate

(%)

THE “CROWDING OUT” EFFECT [Incr G incr I.R. Decr Ig]THE “CROWDING OUT” EFFECT [Incr G incr I.R. Decr Ig]

16

14

12

10

8

6

4

2

05 10 1515 20 25 30 35 40

CrowdingCrowdingOutOut

EffectEffect

ASAS

ADAD11AD2AD2

4%

2%

YY

GG

IIGG

G can finance a deficit by:G can finance a deficit by:1. 1. Borrowing Borrowing - this raises interest rates and- this raises interest rates and ““crowds out”crowds out” investment. investment.2. 2. MoneyMoney Creation Creation - - no “crowding outno “crowding out” so is ” so is more expansionarymore expansionary than borrowing. than borrowing.

FriedmanFriedmanJust follow theJust follow the

““monetary rule.”monetary rule.”

IID1D1

Investment (billions of dollars)

Re

al i

nte

res

t ra

te (

%)

THE “CROWDING In” EFFECTTHE “CROWDING In” EFFECTBut … if the economy is operating well below its potential, the increased G could result in more jobs, more positive profit expectationspositive profit expectations, and a “crowding incrowding in” of Ig.

16

14

12

10

8

6

4

2

05 10 15 20 2525 30 35 40

IID2D2

ASAS

ADAD11ADAD22

YYRR YY**

GG

How “Crowding In” Might WorkHow “Crowding In” Might Work“Crowding In” – potential for G spending to stimulateprivate investment in an otherwise sluggish economy.“Crowding OutCrowding Out” represents argument for passive fiscal policy.“Crowding InCrowding In” would be an argument for active fiscal policy.

If the economy is operating well below its potential, the additionalfiscal stimulus provided by deficit spending could encourage firms to invest more. A G deficit could stimulate a weak economy, increasingAD & putting a “sunny face on business expectations.” As businessexpectations grow more favorable, firms could become more willingto invest. [thus, “crowding in” of investment] If you have ever approached a crowded restaurant, you may not have wanted to put up with the hassle of a long wait and were thus“crowded out.” Similarly, large G deficits may drive up interest ratesand crowd out some investment.

On the other hand, did you ever pass up a restaurant because the placeseemed dead-it had few customers. Perhaps you wondered why so few people chose to eat there. With just a few more customers, you might havebeen willing to “crowd in.” Businesses may be reluctant to invest in a lifelesseconomy. Economic stimulus could encourage them to “crowd in.”

As Yoga Berra would say, “No one goes “No one goes there any more. It’s too crowded.”there any more. It’s too crowded.” Yoga also said, “If you come to a fork in Yoga also said, “If you come to a fork in the road, take it.”the road, take it.”

•Pay Down the Public Debt•Reduce Taxes•Increase Government Spending •Bolster Social Security Trust Fund

•Combination of these Policies

OPTIONS FOR THE SURPLUSESOPTIONS FOR THE SURPLUSES

Crowding-out Crowding-out effect in an Open Economy[Xn are crowded-out, decreasing AD]

1. Federal Government

deficits

2. High real U.S. interest

rates

3. Decline indomestic inv.(crowding-out)

4. Increasedforeign demandfor U.S. bonds

5. IncreasedU.S. external

debt

6. Increasedinternational

value of dollar

7. U.S.Exportsdecrease

8. U.S.Importsincrease

10.Tradedeficits

9. Decr in Xn decr AD

Gramm-Rudman-HollingsGramm-Rudman-Hollings[Attempt to balance the budget which failed][Attempt to balance the budget which failed]

(declared unconstitutional)(declared unconstitutional)

Deficit Related ProblemsDeficit Related Problems1. We could have a constitutional amendmentconstitutional amendment to balance the budget. However, this would be pro-cyclical and destabilize the economy.2. Gramm-Rudman-Hollings ActGramm-Rudman-Hollings Act – budget was to be balanced by 1991(revised to 96). The Supreme Court later ruled it unconstitutional.

3. Tax IncreasesTax Increases – Perot wanted to raise gasoline taxes 50 cents a gallon.

4. PrivatizationPrivatization – U.S. government could sell its assets. Britain sold $25 billion of government assets in the 80s.

5. Line-item vetoLine-item veto – the President could veto particular portions. Supreme Court declared this unconstitutional. This would get rid of “pork-barrelpork-barrel” legislation.

6. Term LimitsTerm Limits for congressmen and senators.

Term LimitsTerm LimitsMaybe 6 years for representatives and 12 for senators, max.

Currently, politicians take our money and convert itinto pork projects to get themselves re-elected. Theymust treat other people’s money the way they treattheir own.

Also, we need to elect politicians who we can tell how much of our money we will let them spend instead of letting them tell us how much they will let us keep.

Debt and Deficit NS 1-6Debt and Deficit NS 1-61. The (national debt/federal budget deficit) consists of the accumulation of all Federal government deficits & surplusesFederal government deficits & surpluses.2. The (national debt/budget deficit) is found by subtractingsubtracting ““G” tax revenues from government spendingG” tax revenues from government spending in one year. 3. How much is the National DebtNational Debt now? _________4. If “G” adhered strictly to an annually balanced budgetannually balanced budget, G’s budget would tend to (stabilize/destabilize) the economy.5. The idea of increasing T during good timesincreasing T during good times & decreasingdecreasing them during bad timesthem during bad times [recessions] [over the course of the business cycle, the budget would be balanced] is the (annually/cyclical) balanced budget.6. The philosophy of functional financefunctional finance is the idea that the main function of the budget is to (stabilize/destabilize) the economy & balancing the budget every year is of (little/extreme) importance.

$7.7 trillion$7.7 trillion

Debt and Deficit NS 7-11Debt and Deficit NS 7-11 7. Budget deficitsBudget deficits were smaller during the

(1970s/1980s & early 1990s)

8. Between 1980 & 19961980 & 1996 the public debt (grew/did not grow) absolutely and as a percentage of GDP.

9. The largest proportion of the public debtlargest proportion of the public debt is held by (foreigners/American public). Therefore we (can/can not) say the public debt is a public credit.

10. The “crowding-out effect”“crowding-out effect” suggests that increases in G spending financed thru borrowing will (increase/decrease) the interest rate and (increase/decrease) private investment.

11. The most likely way the public debt imposes a burden on public debt imposes a burden on future generationsfuture generations is by reducing the current level of (employment/capital accumulation), thus giving us a smaller “national factory.”

Debt and Deficit NS 12-14Debt and Deficit NS 12-14

12. Large budget deficitsbudget deficits (increase/decrease) domestic interest rates, (increase/decrease) the international value of the dollar, and (increase/decrease) American net exports which (enhance/diminishes) expansionary fiscal policy.

13. The line-item vetoline-item veto would have permitted the president to (add/delete) individual projects and programs from larger appropriation bills.

14. The (GDP/GNP/GRH) was a program designed to balance program designed to balance the budgetthe budget.

o

ASAS11

PL1[3%]PL1[3%]

PL2[8%]PL2[8%]

YY11 YY22

a2

a1

ASAS22

b1

LRASLRAS

Higher PL results in higher nominal Higher PL results in higher nominal

wages and shifts SRAS left.wages and shifts SRAS left.

Inflat.Inflat.GapGap

Y & employment increasedY & employment increasedin the SR but not the LR.in the SR but not the LR.

3. An unanticipatedunanticipated increase in PL will lead to (lower/higher) product prices, (decrease/increase) in profits and a(an)

(decrease/increase) in unemp. in SRSR.

4. With the unanticipatedunanticipated increase in PL, Y/employ. did (incr/decr) in the

SR SR but (decreased/increased/stayed the same) in the LRLR.

Test Review1-4Test Review1-41. What is the monetary rulemonetary rule?2. If a household spends $100,000 per year, & on average holds a money balance of $20,000, their velocityvelocity of money is ____.

Increase the MS 3-5% a yearIncrease the MS 3-5% a year

55

ADAD11

ADAD22

Test Review 5-7Test Review 5-7

5. The two main variants of the natural rate hypothesistwo main variants of the natural rate hypothesis are (RATEX/Keynesian/Adaptive Expectations/Reaganomics).

6. According to the MonetaristsMonetarists, the investment demand curveinvestment demand curve is more (flat/vertical) and the money demand curvemoney demand curve is more (flat/vertical). 7. Does the economy self-correct if prices are flexible butprices are flexible but wages are notwages are not? _______nono

o

ASAS11

PLPL11[3%][3%]

PLPL22[8%][8%]

YY11

a2

a1

AS2

b1

LRASLRAS

Real domestic output

Y & eY & employmployment ment increasedincreased

in the SR but not the LR.in the SR but not the LR.

8. An unanticipatedunanticipated increase in AD would result in output (incr/decr/stay same) in SRSR, but (incr/decr/stay same) in LRLR.9. An anticipatedanticipated incr in AD would result in Y (incr/decr/stay same)

in the SRSR and (incr/decr/stay same) in the LRLR.

Test RTest Revieweview 8-9 8-9

o

PL1[1%]PL1[1%]

YY33

ASAS11

PLPL11[3%][3%]

PLPL22[8%][8%]

YY11 YY22

a2

a3

aa11

ASAS22

b1

ASAS33

cc11

LRASLRAS

Real domestic outputReal domestic output

Review of SRAS & LRASReview of SRAS & LRASLower PLLower PL reduces nominal wages & shifts reduces nominal wages & shifts SRAS rightSRAS right..

Recess.Recess.GapGap

Y & employment decreasedY & employment decreasedin the SR but not the LR.in the SR but not the LR.

10. In the LRLR, a decline in inflation will

(incr/decr/not affect) Y/emp.[decr in SRSR, not LRLR]

11. If decline in inflation is anticipatedanticipated,

Y/emp. will incr/decr/not chg) in SRSR. [or LRLR]

T.R. 10-11T.R. 10-11

ADAD11

ADAD22

Test Review 12-18Test Review 12-18

12. An annually balanced budgetannually balanced budget is pro-cyclicalis pro-cyclical because tax

revenue reductions associated with recession will require (increases/decreases) in G spending or increases in taxes.

13. Proper monetary policy monetary policy duringduring inflationinflation is (raise, raise, sell/ lower, lower, buy) Discount Rate, RR, & bonds.

14. An increase in the MSincrease in the MS will lead to a(an) (increase/decrease) in the interest rate & (decr/incr) AD.

15. “Crowding out”“Crowding out” is something the Keynesians/Monetarists) believe strongly in.

16. Selling bondsSelling bonds by the Fed would result in a (smaller/larger) MS and (lower/higher) interest rates.

17. If you are estimating your expensesestimating your expenses for the prom at $800$800, then you are using money as (UA/ME/SV).

18. Foreign individuals and governments (hold/do not hold) most of the Public DebtPublic Debt.

Test Review 19-24Test Review 19-2419. Fiscal policyFiscal policy is thought to work best at fighting (inflation/

depressions) and monetary policymonetary policy is thought to work best

at fighting (inflations/depressions).

20. The Laffer curveLaffer curve was a cornerstone of

(RATEX/Supply-side/ Keynesians) economics.

21. The tight money cause-effect chaintight money cause-effect chain is (incr/decr) the MS, which would (incr/dec) the interest rate, which would (incr/decr) Ig, which would (incr/decr) AD and GDP.

22. The easy money cause-effecteasy money cause-effect chain is (incr/decr) the MS, which would (incr/decr) the interest rate, which would (incr/decr) Ig, which would (incr/decr) AD and GDP

23. The (Monetarists/New Keynesians) are advocates of advocates of monetary and fiscal policymonetary and fiscal policy.

24. An easy money policyeasy money policy will cause the dollar to (apprec/deprec) and cause American Xn to (incr/decr).

Test Review 25-33Test Review 25-33

25. A tight money policytight money policy will cause the dollardollar to (apprec/deprec) and cause American net exportsnet exports to (increase/decrease).

26. A bank loan from the Fedbank loan from the Fed will (increase/decrease/not affect) RR, but (increase/decrease/not affect) ER & TR.

27. A bank deposit by the publicbank deposit by the public will (increase/decrease) RR,ER, & TR.

28. RATEXRATEX are strong advocates that the public’s expectations

(strongly influence/negate) fiscal & monetary policy.

29. The intellectual roots of monetarismintellectual roots of monetarism are based on (Classical/Keynesian) economics.

30. An adherence with an annually balanced budgetadherence with an annually balanced budget would (stabilize/destabilize) the economy.

31. If there is a decrease in AD and prices are not flexibleprices are not flexible, the resulting recession will be worse because equilibriumequilibrium will be (lower/higher) than with flexible prices.

32.In the SSRRPPCC, there (is a/is no) tradeoff between inflation & output, and in the LRPCLRPC there (is a/is no) tradeoff between inflation and unemployment.

33. The (SRPC/LRPC) is consistent with the traditional Phillips curvetraditional Phillips curve.

RR RR is is 25% Assets 25% Assets DDDD(Liabilities)(Liabilities) TR[RR+ER]=$100 TR[RR+ER]=$100 mil.mil. $400 million $400 million

1. How much can this 1. How much can this bankbank loan out? $______ loan out? $______2. If Christina A. Christina A. puts __________________ in this bankbank(DDDD), ER will increase by $$_______.

3. Possible Money Creation in the system could be $$________.

4. Potential Total Money Supply could be as much as $$_________.

00

7,5007,500

$30,000$30,000

40,000 40,000

Extra PracticeExtra Practice MS = Currency + DD of public

$10,000$10,000

RR RR is is 25% Assets 25% Assets DDDD(Liabilities)(Liabilities)

TR[RR+ER] = TR[RR+ER] = $100 mil.$100 mil. $400 million

11. How much can 11. How much can Christina’sChristina’s bankbank loan out? $______ loan out? $______12. If Christina’s BankChristina’s Bank borrows $10,000 from the FedFed ER will increase by $$_______.

13. Possible Money Creation in the system could be $$_________.

14. Potential Total Money Supply could be as much as $$__________.

00

10,00010,000

40,00040,000

40,00040,000

Extra PracticeExtra Practice MS = Currency + DD of Public

Christina’s BankChristina’s BankFedFed

34. If the RR is 50% and the FedFed buys $100 M of bonds from the publicpublic, then the MSMS is increased by _______. ER are increased by ______. PMC is _______. TMS would be ______.35. RR is 40% and the Bishop BankBishop Bank borrows $100 M from the FedFed. As a result, RR are increased by ______. ER is increased

by _______. PMC and TMS is increased by ________.36. Your bankbank has DDDD of $200,000 and the RR is 50%. If RR and ER are equal, then TR are _______.37. The Duck BankDuck Bank has ER of $75,000 & DD is $100,000. If the RR is 20%, TR are _________.38. RR is 10% & the FedFed buys $10 million of bonds from the publicpublic. The MSMS is increased by _______. ER are increased by _______. PMC is _______. TMS would be _________.

Test Review 34-38 Money Creation QuestionsTest Review 34-38 Money Creation Questions

$100 M$100 M

$50 M$50 M $100 M$100 M $200 M$200 M

$100 M$100 M $250 M$250 M

$200,000$200,000

$95,000$95,000

$10 M$10 M

$9 M$9 M $90 M$90 M $100 M$100 M

00

BanksBanks PublicPublic FedFed

1. If the RR is 40% and the FedFed buys $100 M of bonds from the publicpublic, then the MSMS is increased by _______. ER are increased by ______. PMC is _______. TMS would be ______.2. RR is 50% and the Bishop BankBishop Bank borrows $100 M from the FedFed. As a result, RR are increased by ______. ER is increased

by _______. PMC and TMS is increased by ________.3. Your bankbank has DDDD of $400,000 and the RR is 25%. If RR and ER are equal, then TR are _______.4. The Duck BankDuck Bank has ER of $60,000 & DD is $200,000. If the RR is 20%, TR are _________.5. RR is 20% & the FedFed buys $50 million of bonds from the publicpublic. The MSMS is increased by _______. ER are increased by _______. PMC is _______. TMS would be _________.

Additional Practice on Money CreationAdditional Practice on Money Creation

$100 M$100 M

$60 M$60 M $150 M$150 M $250 M$250 M

$100 M$100 M $200 M$200 M

$200,000$200,000

$100,000$100,000

$50 M$50 M

$40 M$40 M $200 M$200 M $250 M$250 M

00

BanksBanks PublicPublic FedFed

Odem Passes Econ

Odem Passes Econ

Terrorist Lose

Goodbye Hassle,Goodbye Hassle,

Hello Tassel.Hello Tassel.

The EndThe End

JuniorsJuniors