Unit 7 Macroeconomics: Taxes, Fiscal, and Monetary Policies Chapters 15.3

1. Unit 7 Macroeconomics: Taxes, Fiscal, and Monetary Policies Chapters 15.3 Economics Mr. Biggs

2. Budget Deficits and the National Debt Balancing the Budget When the federal government’s revenues equal its expenditures in any year, the federal government has a balanced budget. Balanced budget - A budget in which revenues are equal to spending. The federal budget is seldom balanced and usually runs at adeficit. Budget deficit - A situation in which the government spends more than it takes in. Budget surplus - A situation in which the government takes in more than it spends.

3. Responding to Budget Deficits • If the government is running a deficit, it • must create money or borrow money. • Creating Money The government could create new money to pay for small deficits, but for large deficits, it could lead to inflation or hyperinflation. Hyperinflation - Very high inflation. For example, post WWI Germany. • Borrowing Money An alternative to creating money is to borrow money by issuing T-bills, T-notes, and T-bonds. Wise borrowing can create more goods and public services but also has serious disadvantages. For example, building airports and highways.

4. The National Debt • The problem with having a yearly deficit • is that it creates a national debt. • National debt - All the money that the • federal government owes to bondholders. • By the end of 2013, it is estimated to be • almost $16 trillion dollars. • At this amount, the government’s overall debt surpasses the total size of the US economy (GDP). • The Difference Between Deficit and Debt • The national deficit is the amount of • money that the government borrows • for one budget. • The national debt is the total of all • deficits and surpluses.

5. Measuring the National Debt • Currently, the national debt is very large, but historically, it increased during times of war and decreased in peace time. • However, during Reagan’s presidency, government spending increased and taxes were lowered. • This trend continued during George W. Bush’s presidency. • Is the Debt a Problem? • In general, two problems can arise from a national debt: • Reduced funds for investment • Interest payment to bondholders

6. Problems of the National Debt • The first problem is that national debt reduces the funds available for businesses to invest and leads to the crowding-out effect. • Crowding-out effect - The loss of funds for private investment due to government borrowing. • The second problem is that the government must pay interest on the money it borrows which is called “servicing the debt”. • Interest payments are expected to total some $4.2 trillion over the next decade. • Other Views of a National Debt • Traditional Keynesian economists believe that fiscal policy is an important tool that can be • used to help achieve full productive capacity. • The benefits outweigh the costs of interest on the national debt unless the debt grows too big (debt > 100% of GDP).

7. Deficits, Surpluses, and the National Debt • Controlling the deficit is difficult because • much of the budget consists of • entitlements, interest paid to bondholders, • and specific budget cuts are often • opposed by groups affected. • Efforts to Reduce Deficits • In the 1980s, the Gramm-Rudman-Hollings • Act was passed and required automatic expenditure reductions if the deficit exceeded a certain amount. • It was declared unconstitutional in 1990. • In 1990, President Bush created the “pay as you • go system” that required Congress to raise enough revenue to cover direct increases in spending. • In 1995, a balanced budget amendment • failed to pass by one vote in the Senate. • People feared it would make the federal • budget too inflexible.

8. End-of-Century Surpluses • By the start of the 21st century, the federal government • was running a surplus for the first time in 30 years. • The surplus was partially • as a result of President • Clinton raising taxes, • a strong economy, • and low unemployment. • The Future of Fiscal Policy • Many economists and politicians now see Keynesian fiscal policy as a way to influence the economy only in the short term.

9. The End