CHAPTER 14QuestionsSlide 3Debt & DeficitsSlide 5The Deficit & the IS CurveFigure 14.1 - An Increase in the Full-Employment Deficit Shifts the IS Curve OutwardMeasuring the Budget BalanceSlide 9Figure 14.2 - A Fall in Real GDPFigure 14.3 - The Full-Employment and the Cash Budget DeficitInflationFigure 14.4 - The Cash Balance and the Inflation-Adjusted Budget BalancePublic InvestmentLiabilities & Generational AccountingThe Steady-State Debt-to-GDP RatioSlide 17Slide 18Slide 19Slide 20SustainabilitySlide 22The Debt-to-GDP Ratio in the U.S.Figure 14.5 - U.S. Debt-to-GDP Ratio Since the Revolutionary WarFigure 14.6 - Federal Revenues and Expenditures as Shares of National Product since the Civil WarEffects of DeficitsPolitical ConsequencesSlide 28Short-Run ConsequencesOpen-Economy EffectsLong-Run EffectsFigure 14.7 - Higher Full-Employment Deficits Reduce InvestmentSlide 33Figure 14.8 - Long-Run Effects of Persistent Deficits on Economic GrowthSlide 35Chapter SummarySlide 37Slide 38Slide 39Slide 40Slide 41Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.14-1CHAPTER 14The Budget Balance, the National Debt, and InvestmentCopyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.14-2Questions•From the standpoint of analyzing stabilization policy, what is the best measure of the government’s budget balance?•From the standpoint of analyzing the effect of changes in the national debt on long-run growth, what is the best measure of the government’s budget balance?Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.14-3Questions•What is the typical pattern America’s debt follows over time?•How has recent experience in the past generation deviated from this traditional pattern of debt behavior?•What are the reasons that we should worry about a rising national debt?•What are the reasons that we shouldn’t worry too much about a rising national debt?Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.14-4Debt & Deficits•The national debt (D) is the amount of money that the government owes those from whom it has borrowed–when government spending < tax revenues, the difference is the government surplus (-d)•the national debt falls by d–when government spending > tax collections, the difference is the government deficit (d)•the national debt rises by dCopyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.14-5Debt & Deficits•Economists are interested in the debt and the deficit for two reasons–the deficit is an index of how government spending and tax plans affect the IS curve–the debt and deficit are closely connected with national savings and investment•a rising debt tends to depress capital formation•a high national debt means that future taxes will have to be higher to pay interest chargesCopyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.14-6The Deficit & the IS Curve•An increase in government purchases or a decrease in taxes increases aggregate demand–the IS curve shifts out•The appropriate measure of fiscal policy is the full-employment deficit (or surplus)–it measures what the government’s budget balance would be if the economy was at full employmentCopyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.14-7Figure 14.1 - An Increase in the Full-Employment Deficit Shiftsthe IS Curve OutwardCopyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.14-8Measuring the Budget Balance•The government budget balance reported in the news is generally the unified cash balance–the difference between the money the government actually spends in a year and the money it takes in–unifies all of the government’s accounts and trust funds–doesn’t take account of changes in the value of government-owned assets or future liabilitiesCopyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.14-9Measuring the Budget Balance•The full-employment budget balance is a better index than the unified cash balance–the cash budget balance can change even when there is no change in government policy to shift the IS curve•tighter monetary policy raises interest rates and lowers real GDP and tax collections–we must adjust the cash balance deficit (surplus) for the automatic fiscal stabilizersCopyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.14-10Figure 14.2 - A Fall in Real GDPCopyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.14-11Figure 14.3 - The Full-Employment and the Cash Budget DeficitCopyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.14-12Inflation•A good measure of the deficit should be a measure of whether the government is spending more in the way of resources than it is taking in–we should correct the officially-reported cash budget balance for inflation–the real deficit (dr) is related to the cash deficit (dc) byD-ddcrCopyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.14-13Figure 14.4 - The Cash Balance and the Inflation-Adjusted Budget BalanceCopyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.14-14Public Investment•Private spending on long-lived assets is called investment–standard accounting treatment of long-lived assets is to spread out their costs over their useful lives (amortization)•The government spends money on long-lived assets–shouldn’t the government amortize these assets?•which government expenditures are capital expenditures?Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.14-15Liabilities & Generational Accounting•The correct way to count the government’s debt is to look at all of its promises to pay money out in the future–this system is called generational accounting•it would examine the lifetime impact of taxes and spending programs on individuals born in specific years and would come up with a balance that could be used for long-term planningCopyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.14-16The Steady-State Debt-to-GDP Ratio•Fiscal policy is sustainable if the debt-to-GDP ratio (D/Y) is heading for a steady state–D and Y must be growing at the same proportional rate•Y grows at a proportional rate equal to the sum of the annual rate of growth of the labor force (n) and the annual rate of growth of labor efficiency (g)gn Yof rate growth