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Current Issues in Macroeconomic Policy. Should We Balance the Federal Budget?. Governments run a deficit when they spend more than they currently receive in revenues either from taxes or fees. A surplus occurs when total revenues exceed total expenditures.
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Should We Balancethe Federal Budget? • Governments run a deficit when they spend more than they currently receive in revenues either from taxes or fees. A surplus occurs when total revenues exceed total expenditures. • Governments run a balanced budget when revenue equals spending—purchases of goods and services or transfer payments.
Should We Balancethe Federal Budget? • Purchases of goods and services are included in GDP, but transfer payments—such as Social Security, welfare payments, and interest on the federal debt—are not included in GDP. • To measure total spending by the government, we use government expenditure to include transfer payments and purchases of goods and services. • The government debt is the total of all past deficits.
Forecasts for the Budget Surplus, 2001-2011 • The Congressional Budget Office (CBO) estimated that the federal government would continue to run surpluses throughout the decade. • The CBO estimated that in 2011 the ratio of debt to GDP would fall to 5.2% from its value of 32% in 2000.
Federal Debt as a Percent of GDP, 1791-2000 • Except for the period in the 1980s, the ratio of debt to GDP rises sharply during wars and falls during peacetime.
Do Deficits Lead to Inflation? • If a government runs a deficit, it is spending more money than it is taking in, and the gap must be covered in some way. • Governments could use a mix of borrowing money and printing money to cover the gap, as long as the total covers its deficits.
Do Deficits Lead to Inflation? • The United States Treasury Department always issues government bonds to finance the deficit. The Federal Reserve has the option of buying existing debt (including new issues). • Economists call the purchase by a central bank of newly issued government bonds monetizing the deficit. • Monetizing the deficit would result in inflation, thus, the U.S. finances only a very small portion of our deficits by creating money.
Is Government Debta Burden on Future Generations? • The national debt can pose two different burdens for society, both of which affect future generations. • A large debt can reduce the amount of capital in the economy and thereby reduce future income and real wages. • A large national debt will mean that future generations will have to pay higher taxes to finance the interest on the debt.
U.S. Deficits and Unemployment Rates, 1970-2000 • Because increases in the unemployment rate signal bad economic times, we expect the deficit to rise and fall with the unemployment rate.
U.S. Deficits and Unemployment Rates, 1970-2000 • Over short periods, deficits can help the economy cope with shocks and maneuver out of recessions.
How Would a Balanced Budget Amendment Really Work? • Many constitutional amendments have been proposed so that each fiscal year the government’s revenues (excluding borrowing) are sufficient to cover expenditures. • Critics of a balanced budget amendment point to many different problems, including the lack of flexibility to deal with recessions; and the use of the constitution as the mechanism to enforce budget rules.
Should the Federal ReserveAim for Zero Inflation? • A zero inflation rate would mean complete price stability. • To achieve zero inflation, the Fed would have to take two actions: • It would have to use monetary policy to bring the inflation rate to zero from a positive level. • It would need to commit to a policy of keeping inflation at zero and not have any other goals.
How Costly Is It to Reduce Inflation? • Economists who study this problem have developed a rough rule of thumb: • When actual unemployment exceeds the natural rate of unemployment by 1 percentage point for one year, the inflation rate falls by 0.5 percentage points per year.
How Costly Is It to Reduce Inflation? • One complicating factor in measuring the costs of reducing inflation is that the burden of increased unemployment would not be evenly spread across the economy. • Some economists argue that if the Fed was credible in its commitment to reduce inflation, the increase in unemployment could be smaller.
Should Monetary PolicyTarget Only Inflation? • A single goal of price stability would enhance credibility, making the private sector more responsive to changes in economic policy. • Economists who object to the Fed’s single goal of price stability point out that automatic fiscal stabilizers are often not sufficient to cushion the economy in the face of shocks.
Should Monetary PolicyTarget Only Inflation? • “Opportunistic disinflation” is a new phrase about monetary policy that encourages the Fed to take advantage of favorable shocks in the economy in order to accomplish a permanent reduction in inflation without creating excess unemployment.
Should Tax Policy BeDesigned Solely for Growth? • The low savings rate in the U.S. economy hurts our long-run growth prospects because our investment spending is limited by our own savings. • Tax systems which are based on consumption do not penalize individuals who save. Sales taxes in the U.S. and value added taxes abroad are familiar examples of consumption taxes.
Will Consumption TaxesLead to More Savings? • Taxes have both a substitution effect and an income effect. • Substitution effect: reducing the tax rate on savings provides direct incentives for increased saving. • Income effect: with lower tax rates on savings, individuals have more wealth and will consume more which means they will also save less.
Will Consumption TaxesLead to More Savings? • Whether savings increase or decrease when tax rates are cut, ultimately must be settled by careful research. • Although there has been much research on the effects of taxation on saving, it is far from conclusive.
Are Consumption Taxes Fair? • In practice, moving to a consumption tax system, for example by exempting the return on savings from the income tax, would have a major impact on the distribution of income in the economy. • It is the wealthy individuals who save the most and earn income through interest, dividends, rents, and capital gains. • Capital assets are highly concentrated among the wealthy in the economy.
