1. AP Economics Mr. Bernstein Module 30: Long-Run Implications of Fiscal Policy: Deficits and the Public Debt February 12, 2015

2. AP Economics Mr. Bernstein Long-Run Implications of Fiscal Policy Objectives - Understand each of the following: Why governments calculate the cyclically adjusted budget balance Why a large public debt may be a cause for concern Why implicit liabilities of the government are also a cause for concern 2

3. AP Economics Mr. Bernstein Budget Deficits: Good or Bad? Normative question 3

4. AP Economics Mr. Bernstein The Budget Balance: a Measure of Fiscal Policy S government =T – G – Transfers Expansionary Policies in T, G or Transfers reduce Budget Balance Contractionary Policies in T, G or Transfers increase Budget Balance G has greater impact than T or Transfers Changes in budget balance often result from, rather than create, changes in the economy 4

5. AP Economics Mr. Bernstein The Cyclically Adjusted Budget Balance Strong relationship between budget balance and business cycle Why? 5

6. AP Economics Mr. Bernstein The Cyclically Adjusted Budget Balance, cont. Cyclically Adjusted Budget Balance separates impact due to deliberate policy from impact due to the current state of the business cycle Is an estimate of what the Budget Balance would be if real GDP = potential output After adjusting for current state of business cycle the government is still running a deficit, policies are not sustainable 6

7. AP Economics Mr. Bernstein The Cyclically Adjusted Budget Balance 7

8. AP Economics Mr. Bernstein Should the Budget be Balanced? Annually balanced budgets would require Cutting spending or increasing taxes in a recession Decreasing taxes or increasing spending in inflationary gap Would this help? Most economists believe budgets should be balanced on the average, not annually Favor using Cyclically Balanced Budgets Political pressure creates difficulty 8

9. AP Economics Mr. Bernstein Deficits, Surpluses and Debt Governments typically borrow to cover deficits This creates Public Debt US Public Debt: http://www.usdebtclock.org/http://www.usdebtclock.org/ Public Debt “Crowds Out” Private Borrowing Reduces flexibility of future budgets Borrowing more…could lead to ugly default Raising taxes, cutting spending…unpopular Printing money…risks inflation 9

10. AP Economics Mr. Bernstein Debt-to-GDP Ratio Measures government ability to pay down debt 10

11. AP Economics Mr. Bernstein Implicit Liabilities Government promises not included in debt stats Social Security Medicare Medicaid Many will change with demographics 11