B.  Fiscal Policy

1.  Government spending and taxation

• Should consider taxes and expenditures at all levels, but usually focus on Federal government

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a.  Taxes

b.  Expenditures

2.  Budget deficits

• Government expenditures > government revenue

• Budget surplus => government revenue > government expenditures

• Measured on a cash basis

- Capital expenditures counted completely in year of expenditure

- Cash flow statement

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• Debt = accumulated deficits 

a.  Borrowing to finance deficits

• Treasury bills - maturity less than one year

• Treasury notes - maturity between one and ten years

• Treasury bonds - maturity greater than ten years 

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b.  Ownership of the debt

• Internal financing - borrow from domestic residents

• External financing - borrow from foreign residents 

c.  Deficits and the interest rate

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• Crowding out - government borrowing  raises interest rates and reduces private borrowing

d.  Impact on real goods market

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3.  Fiscal policy

• Changes in government spending and taxation to affect the economy

• Changes in government spending affects G, changes in taxes affect C and I

a.  Recessions

• Need to stimulate economy to reduce unemployment

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b.  Inflationary expansions

• Need to slow economy to reduce inflation

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c.  Lags

• Delay between when problem starts and when policy has impact on problem

(1)  Recognition lag - takes time to recognize that a problem exists

• About 3 - 6 months

(2)  Implementation lag - takes time to take action (pass legislation)

• 3 months to 2 years

(3)  Impact lag - takes time for policy to have an impact

• 3 months to 1 year

• Lags are long and variable => problem may be over by the time policy has impact

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4.  Problems with deficits and debt

• Are deficits and debt a problem?

a.  Measures

(1)  Real per capita debt

• Correct for inflation and population growth

• p. 410

(2)  Debt-to-GDP ratio

• Equivalent to debt-to-income ratio

• p. 412

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b.  Issues

(1)  Do government debts have to be repaid?

• Governments can theoretically live forever => can keep borrowing to repay debts

• Same as corporations

• More important is whether debts can be serviced

• Eliminating debt would mean eliminating Treasury securities => financial markets impacted

(2)  Are government debts burdens on future generations?

• Not if used well in the present, i.e., productive investments

• Future generations can continue to borrow to push debt into future

• Problem if more productive private sector investments are crowded out

(3)  Can governments default on loans?

• Ex.  - Mexico (1994), Russia (1998), Brazil (1998), Argentina (2002)

• Could happen if government issues debt denominated in a foreign currency

• Independence of central banks => may not be able to print money to pay domestic currency-denominated debt