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Chapter 12 federal budgets-and-public policy

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  • 1. MacroECONMcEachern 2010-2011CHAPTER12Designed byAmy McGuire, B-books, Ltd.FederalBudgets andPublic PolicyChapter 13 Copyright 2010 by South-Western, a division of Cengage Learning. All rights reserved 1

2. The Federal Budget Process Federal budget Federal government shifted focusLO1 Outlays Government purchases Transfer payments Revenues Specific period From national defense To redistributionChapter 13 Copyright 2010 by South-Western, a division of Cengage Learning. All rights reserved 2 3. Exhibit 1LO1Defenses Share of Federal Outlays DeclinedSince 1960 and Redistribution IncreasedChapter 13 Copyright 2010 by South-Western, a division of Cengage Learning. All rights reserved 3 4. LO1Presidential andCongressional Roles The President Budget proposal Budget request from each agency The budget of U.S. government toCongress Council of Economic Advisors Economic report of the President House and Senate Budget committees: Budget resolutionChapter 13 Copyright 2010 by South-Western, a division of Cengage Learning. All rights reserved 4 5. LO1Presidential andCongressional Roles Budget deficit: Outlays > Revenues Stimulates AD in short run Reduces national saving Long run: hinder economic growth Budget surplus: Revenues > Outlays Dampens AD in short run Boosts domestic saving Long run: promote economic growthChapter 13 Copyright 2010 by South-Western, a division of Cengage Learning. All rights reserved 5 6. LO1Problems withFederal Budget Process Continuing resolutions Instead of budget decisions Lengthy budget process Uncontrollable budget items No separate capital budget Overly detailed budgetChapter 13 Copyright 2010 by South-Western, a division of Cengage Learning. All rights reserved 6 7. LO1Possible Budget Reforms Biennial budget (two-year budget) Simplify the budget document Federal spending Capital budget Operating budgetChapter 13 Copyright 2010 by South-Western, a division of Cengage Learning. All rights reserved 7 8. Rationale for deficits Budget philosophies and deficitsLO2Fiscal Impact of theFederal Deficits Outlays that increase economysproductivity Annually balanced budget Cyclically balanced budget Functional financeChapter 13 Copyright 2010 by South-Western, a division of Cengage Learning. All rights reserved 8 9. Federal deficits: since birth of the nationLO2Fiscal Impact of theFederal Deficits 1789-1930 Deficit: 33% of years (war) Since the Great Depression Deficit: 85% of years 1980s relatively large deficits Large tax cuts High defense spending 1990s: improved economy Decreasing deficits By 1998: surplusChapter 13 Copyright 2010 by South-Western, a division of Cengage Learning. All rights reserved 9 10. Federal deficits: since birth of the nationLO2Fiscal Impact of theFederal Deficits 2001 recession Tax cuts Higher federal spending Deficits Weak recovery War against terrorism 2003, deficit 3.5% of GDP 2007 stronger economy Rising stock market Deficit 1.2% of GDP 2009 deficit of $1.8 trillion projectedChapter 13 Copyright 2010 by South-Western, a division of Cengage Learning. All rights reserved 10 11. LO2 Exhibit 2After Decades of Federal Budget Deficits,Surpluses Appeared from 1998 to 2001, ButDeficits Are BackChapter 13 Copyright 2010 by South-Western, a division of Cengage Learning. All rights reserved 11 12. Why have deficits persisted?LO2Fiscal Impact of theFederal Deficits Tax cuts Spending increase Federal officials Not required to balance the budget Elected officials Big spending programs Small taxes Pork-barrel spendingChapter 13 Copyright 2010 by South-Western, a division of Cengage Learning. All rights reserved 12 13. Increase federal deficitsLO2Fiscal Impact of theFederal Deficits National saving reduced Interest rates higher Investment Discouraged (crowdingout) Stimulated (crowding in)Chapter 13 Copyright 2010 by South-Western, a division of Cengage Learning. All rights reserved 13 14. Crowding-Out Effect Crowding-out effect in an open economy:Larger budget deficits and higher real interestrates lead to an inflow of capital, appreciationin the dollar, and a decline in net exports.Chapter 13 Copyright 2010 by South-Western, a division of Cengage Learning. All rights reserved 14 15. Crowding-Out in an Open EconomyIncrease inbudgetdeficitHigherrealinterestratesDecline inprivateinvestmentInflow of financialcapital from abroadAppreciationof the dollarDecline innet exports An increase in government borrowing to finance an enlargedbudget deficit places upward pressure on real interest rates. This retards private investment and Aggregate Demand. In an open economy, high interest rates attract foreign capital. As foreigners buy more dollars to buy U.S. bonds and otherfinancial assets, the dollar appreciates. The appreciation of the dollar causes net exports to fall. Thus, the larger deficits and higher interest rates triggerreductions in both private investment and net exports, whichlimit the expansionary impact of a budget deficit.Chapter 13 Copyright 2010 by South-Western, a division of Cengage Learning. All rights reserved 15 16. Conclusion of Crowding-Out 2 factors: Private spending and attract inflow ofcapitalChapter 13 Copyright 2010 by South-Western, a division of Cengage Learning. All rights reserved 16 17. The twin deficitsLO2Fiscal Impact of theFederal Deficits Finance huge deficits U.S. Treasury sells IOUs High interest rates Greater demand for $ U.S. trade deficit increase Foreigners buy U.S. assets Increase I Decline SChapter 13 Copyright 2010 by South-Western, a division of Cengage Learning. All rights reserved 17 18. The short-lived budget surplusLO2Fiscal Impact of theFederal Deficits Tax increases 1990, spending cuts Decrease deficits Slower growth in federal outlays 1990-2000 reduced U.S. military abroad Interest rates decreased A reversal of fortune in 2001 Recession + Terrorist attacks Great federal spending 2002 federal deficitChapter 13 Copyright 2010 by South-Western, a division of Cengage Learning. All rights reserved 18 19. During the 1990s, Federal OutlaysDeclined Relative to GDP and RevenuesIncreased, Turning Deficits into Surpluses,But Not for LongLO2Exhibit 3Chapter 13 Copyright 2010 by South-Western, a division of Cengage Learning. All rights reserved 19 20. LO2Case StudyReforming Social Security and Medicare Social Security From: current workers,employees To: current retirees (pensions) $1,000 per month Medicare From: payroll taxes To: short-term medical carefor the elderly $11,000 per beneficiary in 2007Chapter 13 Copyright 2010 by South-Western, a division of Cengage Learning. All rights reserved 20 21. LO2Case StudyReforming Social Security and Medicare 76 million baby boomers 1940: 42 workers per retiree 2007: 3.3 workers per retiree 2030: 2.1 workers per retiree Reforms Increase taxes Reduce benefits Raise the eligibility age Smaller annual increases Reduce benefits towealthy retireesChapter 13 Copyright 2010 by South-Western, a division of Cengage Learning. All rights reserved 21 22. Government Outlays as a Percentageof GDP Declined Between 1994 and 2008in Most Major EconomiesLO2Exhibit 4Chapter 13 Copyright 2010 by South-Western, a division of Cengage Learning. All rights reserved 22 23. The National DebtLO3 National debt Net accumulation of past deficits Measuring the national debt Gross debt U.S. Treasury notes by federalagencies Debt held by the public U.S. Treasury securities Households; Firms Banks (include the Fed) Foreign entitiesChapter 13 Copyright 2010 by South-Western, a division of Cengage Learning. All rights reserved 23 24. LO3 Exhibit 5Federal Debt Held by the Public as aPercentage of GDP Since 1940Chapter 13 Copyright 2010 by South-Western, a division of Cengage Learning. All rights reserved 24 25. The National DebtLO3 International perspective on publicdebt Different economies Different fiscal structures 40% of GDP Australia No debt Japan Debt: 88% of GDPChapter 13 Copyright 2010 by South-Western, a division of Cengage Learning. All rights reserved 25 26. Relative to GDP, U.S. Net Public Debt in 2008Was LO Above Average for Major Economies 3Exhibit 6Chapter 13 Copyright 2010 by South-Western, a division of Cengage Learning. All rights reserved 26 27. The National DebtLO3 Interest on the national debt Buyers of federal securities Individuals, $25 Institutions, $1 million Increasing interest rates 1 percentage pointincrease in nominalinterest rate Interest cost increase $58billion per yearChapter 13 Copyright 2010 by South-Western, a division of Cengage Learning. All rights reserved 27 28. LO3 Exhibit 7Interest Payments on Federal Debt Held by the Publicas a Percentage of Federal Outlays Peaked in 1996Chapter 13 Copyright 2010 by South-Western, a division of Cengage Learning. All rights reserved 28 29. The National DebtLO3 Who bears the burden of debt? Billing future taxpayers For current spending We owe it to ourselves Future generations Service the debt Receive the payments Foreign ownership of debt Increase burden of debt Future generations of AmericansChapter 13 Copyright 2010 by South-Western, a division of Cengage Learning. All rights reserved 29 30. Foreign Holders of U.S. TreasurySecuritiesLO3Exhibit 8Chapter 13 Copyright 2010 by South-Western, a division of Cengage Learning. All rights reserved 30 31. The National DebtLO3 Crowding out and capital formation Deficit spending, long run Borrowed funds invested inpublic capital Increased productivity Increased standard of living Borrowed funds currentexpenditures Less capital formationChapter 13 Copyright 2010 by South-Western, a division of Cengage Learning. All rights reserved 31 32. The National DebtLO3 Intergenerational view of deficits anddebt Welfare of generations Tied together Parents now Consume less Save more Reduce the burden on nextgeneration Issues People with no children Informed of federal spendingChapter 13 Copyright 2010 by South-Western, a division of Cengage Learn

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