2 Deficit A deficit is a shortfall of incoming revenues vs. spending If revenues exceed spending >Budget SurplusIf revenues equal spending >Balanced BudgetIf spending exceed revenue >Budget DeficitDeficits happen because of overspending, debt payments, war financing, national emergencies, fiscal policy
3 National DebtThe national or public debt is total accumulation of the deficits (minus the surpluses) the Federal government has incurred through time.As debt grows, governments must borrow money to operate and pay interest.This is done with Treasury Bonds – (Deficit Spending)The accumulated debt is the national debt
4 Two Kinds of Debt External government debt Internal government debt debt owed individuals in foreign nations.Internal government debtdebt owed to its own citizens
5 Activity (Group) Discuss if debt is/is not something to worry about? Make a “T” Chart and turn in as a group at the end
6 Why Debt is BadWe have to spend on paying debt and interest (Opportunity cost)Obligation passed on to next generation (That means you)Foreign Dependence for financing(China)Private-sector can’t borrow money because government is borrowing it(Crowding Out effect)
7 How debt is good Access to more then a cash society Can build wealth - ?Drives Growth/expansion“Buy” into system (Social Control)
8 But....Government debt is different than an individual’s debt. Since government is ongoing, it never has to settle its accountsGovernments can pay off debt by creating money.(For a short time)Government can collect taxes to pay the debtNation has vast assetsAmericas Role in the World*
14 Two Types of Policy Expansionary Increase Government Spending/SubsidiesTax ReductionsCombinations of the TwoResult: Demand for goods growMore people employedInflation
15 Two Types of Policy Contractionary Decrease Government Spending/SubsidiesTax IncreasesCombinations of the TwoResult: Demand for goods slowsMore people unemployedInflation Less
16 Types of spending Discretionary spending Government can spend on whateverNon-Discretionary SpendingMust be spent on certain programsCan’t change unless laws are changed first.
17 Non-Discretionary Spending (Automatic Stabilizers) – Those elements of the federal budget that by law change counter to the business cycle* unemployment benefits* welfare benefits* income tax revenueNo delay, or lag, because of political controversies, administrative problems
18 Problems with Using Fiscal Policy Rational ExpectationsTiming IssuesPolitical IssuesRegional Differences
19 Rational Expectation Theory If individuals of Business know of policy changes that may effect them they take action to limit the impact of the changes.Example: TAXESOnly applies when people know IN ADVANCE of a policy.
20 Fiscal Policy Timing Issues Recognition lagAdministrative lagOperational lag
21 Timing Issues- Recognition Lag Time it takes for majority to understand/ acknowledge a problem and pick course of action.(Surveys, Economic Indicators)
22 Timing IssuesRecognition lagAdministrative lagOperational lag
23 Timing Issues- Administrative Lag Time it takes to write and implement the laws/policy to fix the problem
24 Timing Issues- Operational lag Time it takes for policy to work
25 Timing Issues Recognition lag Administrative lag Operational lag -3 Months for information to become available.Administrative lag~3 Months because Federal legislation is requiredOperational lag~6-12 Months to see result
26 The political business cycle The tendency of the political elements of a government to create instability by:Reducing taxes before electionsIncreasing government spending before electionsRaise taxes after elections
27 Regional DifferencesIssues will vary from region to region so policy may not work the same all over.
28 Bail-Outs (Activity)Question: Do you think it is “right” for government to bail out companies. Why or why Not-Explain your reasons and turn in at end of hour.
30 What is monetary policy? Monetary Policy : Are the tools used by governments to affect the economy.So.....If government can affect how much it costs to borrow money, how much money is in circulation and how people spend they should be able to influence economy.
31 The Federal Reserve System Central BankFederal Reserve Bank– AKA “The Fed”Quasi-public AgencyHas twelve regional privately-owned Federal Reserve BanksAct as fiscal agents for the U.S. Treasury
34 Why Have a Central Bank? Activity (Class) Think of some possible reasons for the creation of the Fed?
35 Why Have a Central Bank? Bank of the Government Central Economic “Authority”Influence EconomyPrint Money etc.Oversee commercial banksBack-up for regular banking systemConfidence/StabilityAvoid political influences
36 Has authority to: Regulate the private banks Make loans to banks (Bankers Bank)Supply money when needed to banksPrint Money, Issue Treasury securitiesRegulate consumer credit systemBank for government agenciesManage exchange rates
37 How the Federal Reserve Controls the Money Supply Board of Governors Sets PolicyCan change the required reserve ratioCan change the discount rateCan engage in open market operations
38 Required Reserve Ratio Ratio of actual currency to investments banks can have.$10010% Reserve Ratio =Bank has $90 to invest elsewhere or loan out
39 The Discount RateThe discount rate is the interest rate that banks pay to the Fed to borrow from it.Increasing interest ratesSlows the economy by making loans more expensivePromotes consumer savings > decreases economic activity• Decreasing interest ratesExpands the economy by making loans less expensivePromotes consumer spending > Increases economic activity
40 Open Market Operations When the Federal Reserve buys or sells securities to influence money supplyDone by: Federal Open Market Committee (FOMC)Fed will buy money =can lend more money cheaply> money supply expandsFed will sell money =less money to lend so more expensive> money supply contracts(FOMC)
41 Open Market Operations Open market operations are the Fed’s preferred means of controlling the money supply because:More preciseExtremely flexibleFairly predictable
42 Transmission LagsThe time between a change in interest rates and when an effect is felt in the economyA typical lag time is 6 to 12 months