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AP Economics

AP Economics. Mr. Bernstein Module 30: Long-Run Implications of Fiscal Policy: Deficits and the Public Debt February 2019. AP Economics Mr. Bernstein. Long-Run Implications of Fiscal Policy Objectives - Understand each of the following:

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AP Economics

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  1. AP Economics Mr. Bernstein Module 30: Long-Run Implications of Fiscal Policy: Deficits and the Public Debt February 2019

  2. AP EconomicsMr. Bernstein Long-Run Implications of Fiscal Policy • Objectives - Understand each of the following: • Why governments calculate the cyclically adjusted budget balance • Why a large public debt may be a cause for concern • Why implicit liabilities of the government are also a cause for concern

  3. AP EconomicsMr. Bernstein Budget Deficits: Good or Bad? • Normative question

  4. AP EconomicsMr. Bernstein The Budget Balance: a Measure of Fiscal Policy • Sgovernment =T – G – Transfers • Expansionary Policies in T, G or Transfers reduce Budget Balance • Contractionary Policies in T, G or Transfers increase Budget Balance • G has greater impact than T or Transfers • Changes in budget balance often result from, rather than create, changes in the economy

  5. AP EconomicsMr. Bernstein The Cyclically Adjusted Budget Balance • Strong relationship between budget balance and business cycle • Why?

  6. AP EconomicsMr. Bernstein The Cyclically Adjusted Budget Balance, cont. • Cyclically Adjusted Budget Balance separates impact due to deliberate policy from impact due to the current state of the business cycle • Is an estimate of what the Budget Balance would be if real GDP = potential output • If after adjustment for current state of business cycle the government is still running a deficit, then policies are not sustainable

  7. AP EconomicsMr. Bernstein The Cyclically Adjusted Budget Balance * - (from EconBrowser.com)

  8. AP EconomicsMr. Bernstein Should the Budget be Balanced? • Annually balanced budgets would require • Cutting spending or increasing taxes in a recession • Decreasing taxes or increasing spending in inflationary gap • Would this help? • Most economists believe budgets should be balanced on the average, not annually • Favor using Cyclically Balanced Budgets • Political pressure creates difficulty

  9. AP EconomicsMr. Bernstein Deficits, Surpluses and Debt • Governments typically borrow to cover deficits • This creates Public Debt • US Public Debt: http://www.usdebtclock.org/ • Public Debt “Crowds Out” Private Borrowing • Reduces flexibility of future budgets • Borrowing more…could lead to ugly default • Raising taxes, cutting spending…unpopular • Printing money…risks inflation

  10. AP EconomicsMr. Bernstein Debt-to-GDP Ratio • Measures government ability to pay down debt • Current US ratio is ~74%, 39th highest in the world

  11. AP EconomicsMr. Bernstein Implicit Liabilities • Government promises not included in debt stats • Social Security • Medicare • Medicaid • Many will change with demographics

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