Federal Budgets and Public Policy

1
Macro
ECON
McEachern 2008-2009
13
CHAPTER
Federal Budgets and Public Policy
Designed by Amy McGuire, B-books, Ltd.
2
The Federal Budget Process

• Federal budget
• Outlays
• Government purchases
• Transfer payments
• Revenues
• Specific period
• Federal government shifted focus
• From national defense
• To redistribution

LO1
3
Exhibit 1
LO1
Defenses Share of Federal Outlays Declined Since
1960 and Redistribution Increased
4
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

LO1
5
Presidential and Congressional Roles

• Budget deficit Outlays gt Revenues
• Stimulates AD in short run
• Reduces national saving
• Long run hinder economic growth
• Budget surplus Revenues gt Outlays
• Dampens AD in short run
• Boosts domestic saving
• Long run promote economic growth

LO1
6
Problems with Federal Budget Process

• Continuing resolutions
• Instead of budget decisions
• Lengthy budget process
• Uncontrollable budget items
• No separate capital budget
• Overly detailed budget

LO1
7
Possible Budget Reforms

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

LO1
8
Fiscal Impact of the Federal Deficits

• Rationale for deficits
• Outlays that increase economys productivity
• Budget philosophies and deficits
• Annually balanced budget
• Cyclically balanced budget
• Functional finance

LO2
9
Fiscal Impact of the Federal Deficits

• 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

LO2
10
Fiscal Impact of the Federal Deficits

• 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

LO2
11
Exhibit 2
LO2
After Decades of Federal Budget Deficits,
Surpluses Appeared from 1998 to 2001, But
Deficits Are Back
12
Fiscal Impact of the Federal Deficits

• 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

LO2
13
Fiscal Impact of the Federal Deficits

• Increase federal deficits
• National saving reduced
• Interest rates higher
• Investment
• Discouraged (crowding out)
• Stimulated (crowding in)

LO2
14
Fiscal Impact of the Federal Deficits

• 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

LO2
15
Fiscal Impact of the Federal Deficits

• 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

LO2
16
Exhibit 3
LO2
During the 1990s, Federal Outlays Declined
Relative to GDP and Revenues Increased, Turning
Deficits into Surpluses, But Not for Long
17
Reforming Social Security and Medicare
LO2

• 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 2007

Case Study
18
Reforming Social Security and Medicare
LO2

• 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

Case Study
19
Exhibit 4
LO2
Government Outlays as a Percentage of GDP
Declined Between 1994 and 2007 in Most Major
Economies
20
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

LO3
21
Exhibit 5
LO3
Federal Debt Held by the Public as a Percentage
of GDP Since 1940
22
The National Debt

• International perspective on public debt
• Different economies
• Different fiscal structures
• 44 of GDP
• Australia
• No debt
• Italy
• Debt 94 of GDP

LO3
23
Exhibit 6
LO3
Relative to GDP, U.S. Net Public Debt in 2007 Was
About Average for Major Economies
24
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 51 billion per year

LO3
25
Exhibit 7
LO3
Interest Payments on Federal Debt Held by the
Public as a Percentage of Federal Outlays Peaked
in 1996
26
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

LO3
27
Exhibit 8
LO3
Foreign Holders of U.S. Treasury Securities
28
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

LO3
29
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

LO3
30
LO3
An Intergenerational View of Deficits and Debt

• Barro model
• assumes parents are concerned about the welfare
  of their children, who, in turn,
• are concerned about the welfare of their children
• and so on for generations.

Case Study
31
LO3
An Intergenerational View of Deficits and Debt

• Barro Parents can reduce the burden of the
  federal debt on future generations by
• consuming less
• saving more

Case Study
32
LO3
An Intergenerational View of Deficits and Debt

• As governments substitute deficits for taxes,
  parents consume less/save more to increase
  gifts/bequests to their children.
• If greater saving offsets federal deficits,
  deficit spending will not increase AD because the
  decline in consumption will negate the fiscal
  stimulus provided by deficits.
• This offsets future burden of higher debt and
  neutralizes effect of deficit spending on AD,
  output, and employment.

Case Study
33
LO3
An Intergenerational View of Deficits and Debt

• Critics
• The evidence fails to support his theory because
  large federal deficits coincided with lower, not
  higher, saving rates.
• Those with no children may be less concerned
  about the welfare of future generations.
• Theory assumes people are aware of federal
  spending and tax policies and about the future
  consequences of current policies.

Case Study