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CSU ECON 204 - Fiscal Policy in the Long-Run

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ECON 204 1st Edition Lecture 12Outline of Last Lecture XVII. Fiscal PolicyOutline of Current LectureXVIII. Long-Run Implications of Fiscal PolicyA. The budget balanceB. Measuring deficitC. Implicit liabilitiesCurrent LectureXVIII. Long-Run Implications of Fiscal PolicyU.S. government budget accounting is calculated on the basis of fiscal years (runs from October 1 to September 30 and is labeled by the calendar year in which it ends). Persistent budget deficits have long-run consequences because they lead to an increase in public debt. Public debt may “crowd out” investment spending, which reduces long-run economic growth. Rising debt may even lead to government default, resulting in economic and financial turmoil.A government printing money to pay its bills leads to inflation.A. The budget balanceThe budget balance is the difference between the government’s tax revenue and its spending both on goods and services and on government transfers.S(Government) = T-G-TRexpansionary fiscal policies reduce the budget balance for that year- making a budget surplus smaller or a budget deficit bigger. contractionary fiscal policies increase the budget balance for that year, making a budget surplus bigger or a budget deficit smaller.Some of the fluctuations in the budget balance are due to the effects of the business cycle. In order to separate the effects of the business cycle from the effects of discretionary fiscal policy, governments estimate the cyclically adjusted budget balance.These notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.The cyclically adjusted budget balance is an estimate of the budget balance if the economy were at potential output.Should the budget be balanced?Most economists believe it is not necessary that the budget be balanced every year. Policy makers believe that there should be an upper limit (or ceiling) on deficits.B. Measuring deficitWidely used measure of fiscal health is the debt-GDP ratioThis represents government debt as a percentage of the GDPThis number can remain stable or fall even in the face of moderate budget deficits if GDP rises over time.C. Implicit liabilitiesImplicit liabilities: spending promises made by governments that are effectively a debt despite the fact that they are not included in the usual debt statistics. These liabilities are affected by demographic change – worrying.Ex: In the U.S. the largest implicit liabilities come from Social Security and


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