Fiscal Policy and Budget Deficits

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Fiscal Policyand Budget Deficits

• Chapter 17

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Budget deficit occurs when expenditures exceed
receipts
Individuals and not businesses pay the majority
of federal income taxes
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A strong economy and controlled spending led to
the first budget surplus in more than 20 years
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While the national debt grew as deficit spending
dominated the 1980s and 1990s, debt as a
percent of GDP stayed within post-WW
II experience
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Fiscal Policy Options

• Automatic fiscal policy instruments take
  effect without explicit action by policymakers
  (e.g., progressive tax rates)
• Discretionary fiscal policy instruments require
  explicit actions by the president or Congress
  (e.g., passing a law)

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Agricultures share of the federal budget is
typically in the 1-2 percent range
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A federal budget deficit requires the U.S.
Treasury to issue more government securities to
balance sources and uses of funds
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An increase in the sale of government
securities reduces the pool of private capital
available to finance investment
expenditures, raising interest rates
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We know from Chapter 14 that higher interest
rates depresses investment expenditures
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The use of expansionary fiscal policy actions to
push aggregate demand from AD1 to AD3
increases real GDP from Y1 to Y3 while only
increasing the general price level to P3.
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The further use of expansionary fiscal policy to
push aggregate demand from AD3 to AD4 increases
real GDP from Y3 to YFE (full employment GDP),
but increases the general price level to P4.
This is almost an even trade-off in terms of the
Phillips curve discussed in Chapter 15.
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The use of expansionary fiscal policy to
attain YPOT by shifting aggregate demand to AD5
will increase the general price level to P5. This
trade-off would make no sense to policymakers.
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