Chapter 12 federal budgets-and-public policy

Designed byAmy McGuire, B-books, Ltd.

McEachern 2010-2011

CHAPTERFederal Budgets and Public Policy

The Federal Budget Process

Federal budget– Outlays• Government purchases• Transfer payments

– Revenues– Specific period

Federal government – shifted focus– From national defense– To redistribution

Defense’s Share of Federal Outlays Declined Since 1960 and Redistribution Increased

Exhibit 1

Presidential and Congressional Roles

The President– Budget proposal• Budget request from each agency• “The budget of U.S. government” to

Congress– Council of Economic Advisors• “Economic report of the President”

House and Senate– Budget committees: Budget resolution

Presidential and Congressional 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 growth

Problems with Federal Budget Process

Continuing resolutions– Instead of budget decisions

Lengthy budget process Uncontrollable budget items No separate capital budget Overly detailed budget

Possible Budget Reforms

Biennial budget (two-year budget) Simplify the budget document Federal spending– Capital budget– Operating budget

Fiscal Impact of the Federal Deficits

Rationale for deficits– Outlays that increase economy’s

productivity Budget philosophies and deficits– Annually balanced budget– Cyclically balanced budget– Functional finance

Federal deficits: since birth of the nation– 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: surplus

Federal deficits: since birth of the nation– 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 projected

After Decades of Federal Budget Deficits, Surpluses Appeared from 1998 to 2001, But Deficits Are Back

LO2 Exhibit 2

Why have deficits persisted?– Tax cuts– Spending increase– Federal officials• Not required to balance the budget

– Elected officials• Big spending programs• Small taxes• Pork-barrel spending

Increase federal deficits– National saving – reduced– Interest rates – higher– Investment• Discouraged (crowding

out)• Stimulated (crowding in)

Crowding-Out Effect

Crowding-out effect in an open economy: Larger budget deficits and higher real interest rates lead to an inflow of capital, appreciation in the dollar, and a decline in net exports.

Increase in budget deficit

Higher realinterest rates

Inflow of financial capital from abroad

Decline inprivate investment

Appreciation

of the dollar

Decline in net exports

Crowding-Out in an Open Economy

• An increase in government borrowing to finance an enlarged budget 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 other financial assets, the dollar appreciates.

• The appreciation of the dollar causes net exports to fall.

• Thus, the larger deficits and higher interest rates trigger reductions in both private investment and net exports, which limit the expansionary impact of a budget deficit.

Conclusion of Crowding-Out

2 factors: Private spending and attract inflow of capital

The twin 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 S

The short-lived budget surplus– 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 deficit

During the 1990s, Federal Outlays Declined Relative to GDP and Revenues

Increased, Turning Deficits into Surpluses, But Not for Long

LO2Exhibit 3

Reforming 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 care

for the elderly $11,000 per beneficiary in

Reforming 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 to

wealthy retirees

Government Outlays as a Percentage of GDP Declined Between 1994 and 2008

in Most Major Economies

LO2Exhibit 4

The National Debt

National debt– Net accumulation of past deficits

Measuring the national debt– Gross debt• U.S. Treasury notes – by federal

agencies– Debt held by the public• U.S. Treasury securities

– Households; Firms– Banks (include the Fed)– Foreign entities

Federal Debt Held by the Public as a Percentage of GDP Since 1940

LO3 Exhibit 5

The National Debt

International perspective on public debt– Different economies• Different fiscal structures

– 40% of GDP– Australia• No debt

– Japan• Debt: 88% of GDP

Relative to GDP, U.S. Net Public Debt in 2008 Was Above Average for Major EconomiesLO3Exhibit 6

The National Debt

Interest on the national debt– Buyers of federal securities• Individuals, $25• Institutions, $1 million• Increasing interest rates• 1 percentage point

increase in nominal interest rate– Interest cost increase $58

billion per year

Interest Payments on Federal Debt Held by the Public as a Percentage of Federal Outlays Peaked in 1996

LO3 Exhibit 7

The National Debt

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 Americans

Foreign Holders of U.S. Treasury Securities

LO3Exhibit 8

The National Debt

Crowding out and capital formation– Deficit spending, long run– Borrowed funds – invested in

public capital• Increased productivity• Increased standard of living

– Borrowed funds – current expenditures• Less capital formation

The National Debt

Intergenerational view of deficits and debt– Welfare of generations• Tied together

– Parents now• Consume less• Save more• Reduce the burden on next

generation– Issues• People with no children• Informed of federal spending

Chapter 12 federal budgets-and-public policy

Documents

Transcript of Chapter 12 federal budgets-and-public policy

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