Explorations in Economics

1. Explorations in Economics Alan B. Krueger & David A. Anderson

2. Chapter 15: Fiscal Policy • Module 44: Government Revenue and Spending • Module 45: Deficits and the National Debt • Module 46: Managing the Business Cycle

3. MODULE 44:GOVERNMENT REVENUE AND SPENDING KEY IDEA: The government uses tax collections to fund its operations and programs. About two thirds of federal government spending is mandated by law. OBJECTIVES: • To identify the sources of federal government revenue. • To specify how the federal government spends its revenue. • To explain the difference between mandatory and discretionary spending.

4. SOURCES OFGOVERNMENT REVENUE All levels of government raise revenue through taxation. • Individual income taxes • payroll taxes • corporate income taxes • estate taxes • gift taxes • import taxes This is a review from Chapter 10

5. SOURCES OFGOVERNMENT REVENUE Selling Government Securities A Treasury bill (T- bill) is a security issued by the U.S. Treasury that matures in 4, 13, 26, or 52 weeks. A Treasury note (T- note) is a U.S. Treasury security that pays interest in the form of coupon payments and matures in 2, 3, 5, or 10 years. A Treasury bond (T- bond) is a U.S. Treasury security that pays interest in the form of coupon payments and matures in 30 years.

6. THE FEDERAL BUDGET The federal budget is a plan for how the federal government will spend money over the coming fiscal year. The fiscal year for the federal government is the period over which the federal budget applies. It begins on October 1 and ends on September 30.

7. THE FEDERAL BUDGETSPENDING Federal Government Spending, 2012

8. HOW THE FEDERAL GOVERNMENT SPENDS OUR MONEY Mandatory spending is spending that is required by existing law. Entitlement programs are programs that people are entitled to by law if they meet certain qualifications.

9. HOW THE FEDERAL GOVERNMENT SPENDS OUR MONEY Transfer payments are payments for which the government receives no goods or services in return.

10. HOW THE FEDERAL GOVERNMENT SPENDS OUR MONEY These are the specific entitlement programs at the federal level. • Which are age eligible? • Which are means tested? • Which require contribution from the entitled? •Which allow the states to set the eligibility requirements? Age eligible? Social Security, Medicare Means-tested? Medicaid, Supplemental Nutrition Assistance Program Require contribution? Social Security, Disability Insurance, Medicare, Unemployment Insurance States set eligibility? Temporary Assistance for Needy Families, Unemployment Insurance

11. HOW THE FEDERAL GOVERNMENT SPENDS OUR MONEY Discretionary spending is government spending that is not required by law; rather, it is authorized annually by Congress and the president.

12. MODULE 44 REVIEW What is… A. Treasury bill B. Treasury note C. Treasury bond D. Face value E. Coupon payments F. Government security G. Fiscal year H. Federal budget I. Mandatory spending J. Entitlement programs K. Means- tested L. Transfer payments M. Appropriation bills N. Discretionary spending

13. MODULE 45 :DEFICITS AND THE NATIONAL DEBT KEY IDEA: When the federal government spends more than it receives in revenues, it runs a deficit for the year and adds to the national debt. Deficit spending is spending in excess of revenues. The National Debt is over $19 Trillion Dola OBJECTIVES: • To identify the difference between an annual deficit and the national debt. • To explain how deficits and debt are related. • To analyze the effects of the national debt on individuals and firms.

14. DEBT, DEFICITS, AND SURPLUSES A budget deficit or budget surplus is the difference between the amount of government payments and the amount of government revenues in a particular year.

15. DEBT, DEFICITS, AND SURPLUSES The national debt is the amount of money that the federal government has borrowed over time to fund annual budget deficits and has not yet repaid.

16. DEBT, DEFICITS, AND SURPLUSES The national debt consists of two categories: • The public debt is the money owed to investors (individuals, banks, pension funds, fund managers, insurance companies, both domestic and foreign) by the federal government. • The intragovernmental debt is the money the federal government owes to government programs such as Social Security and Medicare.

17. DEBT, DEFICITS, AND SURPLUSES A balanced budget is a budget designed to equate expected revenues with planned expenditures. Reasons for Annual Deficits • Most are planned to achieve worthwhile payoffs. • As economic performance falters, social services increase and government tries to jump-start the economy with spending and assistance.

18. DEBT, DEFICITS, AND SURPLUSES Borrowing to Fund Deficits Treasury Inflation-Protected Securities (TIPS) are U.S. Treasury securities that protect investors against inflation because the amount to be repaid rises with inflation. The Federal Reserve (the Fed), the central bank of the United States, buys US government securities. When the Federal Reserve uses money that was not in circulation to purchase securities, the practice is called monetizing the debt.

19. DEBT, DEFICITS, AND SURPLUSES The debt to GDP ratio is important in evaluating a nation’ s ability to repay the debt. The debt limit is the highest amount that the national debt can reach, as authorized by Congress.

20. THE EFFECTS OF THENATIONAL DEBT Higher Interest Rates Dividends are payments made out of a corporation’s profits to owners of its stocks. The federal government makes interest payments to US debt owners. As investors buy the government debt, they have less funds for private investment. The crowding- out effect is the constraint on private sector borrowing that results from higher interest rates due to government borrowing.

21. THE EFFECTS OF THENATIONAL DEBT The Burden on Future Generations The payment of interest on the national debt is called servicing the debt. As the size of the debt grows, the amount of the interest payments must be increased. The Risk of Foreign Investment As foreigners buy our debt, the interest payments end up outside the US economy. Without this foreign buying of our debt, we would have less to spend and boost the US economy. Some Good News about the National Debt Taxation, printing money, and the ability to pay the interest on the debt is relatively positive news.

22. MODULE 45 REVIEW What is… A. Deficit spending B. Budget deficit C. Budget surplus D. National debt E. Balanced budget F. Treasury Inflation- Protected Securities G. Federal Reserve H. Monetizing the debt I. Debt limit J. Public debt K. Intragovernmental debt L. Dividends M. Crowding- out effect N. Servicing the debt

23. Fiscal Policy:MANAGING THE BUSINESS CYCLE KEY IDEA: The Federal Government has several tools that sometimes help smooth out contractions and expansions in the economy. OBJECTIVES: • To explain the difference between contractionary and expansionary fiscal policies. • To analyze the problems associated with economic forecasting. • To convey the difference between discretionary fiscal policies and automatic stabilizers.

24. LOOKING FOR MACROECONOMIC EQUILIBRIM Macroeconomic equilibrium occurs when aggregate supply equals aggregate demand. Fiscal policy is the use of government spending and taxation to pursue economic growth, full employment, and price stability.

25. LOOKING FOR MACROECONOMIC EQUILIBRIM Disposable income is income after taxes have been removed. This is the money now available for either spending or saving. Changes to tax rates & the effect of transfer payments can affect aggregate demand.

26. LOOKING FOR MACROECONOMIC EQUILIBRIM Expansionary fiscal policy Any combination of government spending and tax cuts meant to spur the economy by increasing spending. The rightward shift of the AD results in a higher price level but higher RGDP.

27. Expansionary Fiscal Policy To expand the Economy: • Government attempts to increase disposable income (lower taxes) and/or to increase government spending (deficit spending). • This is fiscal policy to correct a recessionary phase of the business cycle. • We need to “pump” up the economy with stimulus spending and/or lower taxes.

28. LOOKING FOR MACROECONOMIC EQUILIBRIM Contractionary fiscal policy Any combination of government spending cuts and tax increases meant to slow the economy down and fight inflation. The leftward shift of the AD results in a lower price level but lower RGDP.

29. Contractionary Fiscal Policy To Contract the Economy Government attempts to reduce disposable income (increase taxes) and/or decrease government spending. This is fiscal policy to correct an inflationary economy. The price level is too high and robbing consumer of spending power. We need to “slow down” the economy (aggregate demand) with lower government spending and/or higher taxes.

30. DISCRETIONARY FISCAL POLICIES Discretionary Fiscal Policy Any Congressional action to increase or decrease taxes and/or change the level of government spending. Discuss how these fiscal policy measures would work: • Change in tax rates on individuals or corporations • Extending unemployment benefits beyond 26 weeks • Change in tax deductions • Changes in business taxes and deductions

31. FISCAL POLICY FLOW CHART

32. FISCAL POLICY FLOW CHART

33. AUTOMATIC STABILIZERS Automatic stabilizers are changes in taxation and transfer payments that moderate changes in GDP and do not require authorization from the government. • Tax Revenues rise in expansionary periods and fall in recessionary periods • Transfer Payments rise in recessionary period and fall in expansionary periods Automatic stabilizers occurs without any vote or discretion necessary by Congress. • Why do tax revenues rise in expansionary periods? Why do they fall in recessionary periods? • Why do transfer payments increase in recessionary periods? Why do they fall in expansionary periods?

34. AUTOMATIC STABILIZERS Demand-side policy is policy meant to stabilize or stimulate the economy by changing aggregate demand. Supply-side policy is policy meant to stimulate the economy by increasing aggregate supply. Why not choose? Incentives for hard work and eliminate regulations where cost is greater than benefit.

35. THE LIMITS OF FISCAL POLICY Mandatory Spending • Controversial to change the very popular entitlement programs like Social Security and Medicare. Congress must change the law. Discretionary Spending • Strong lobbying efforts for specific spending like national defense, medical research, environmental protection and others.

36. THE LIMITS OF FISCAL POLICY An inside lag is a delay between the onset of a problem and the implementation of a solution. A recognition lag is the time it takes economists and government officials to realize that the economy is experiencing a problem. An outside lag is the time between a policy action and the resulting effect on the economy. Unintended Consequences means poorly timed efforts can push the economy in the opposite direction of what is intended.

37. MODULE 46 REVIEW What is… A. Fiscal policy B. Macroeconomic equilibrium C. Disposable income D. Expansionary fiscal policy E. Contractionary fiscal policy F. Discretionary fiscal policy G. Automatic stabilizers H. Demand- side policy I. Supply- side policy J. Inside lag K. Recognition lag L. Implementation lag M. Classical economics N. Keynesian economics O. Outside lag