Page 18-24 Presented by Ahmad Bash

It is true that today’s children will pay taxes as adults to service this debt. Yet they will also inherit T-bonds and receive the interest payment financed The increase in taxes on tomorrow’s generation needed to finance this debt will be offset by the increase in interest income that these taxes pay for Of course, not everyone will own T-bill, they are form of wealth that is held by some households, yet everyone should pay taxes (intergenerational issue)

Budget deficit and foreign indebtedness The government is borrowing what the US private sector is saving, so we are paying for all this stimulus

There is no shortage of people willing to hold gov bonds; rather, the problems is the shortage of people who want to incur debt (borrow) in order to undertake spending American households and businesses are saving too much relative to investment demand (this is the problem that the stimulus package is trying to solve)

A real concern for generational fairness: the trade deficit While domestic savings have been sufficient to finance new gov borrowings over the past year, about half of gov debt is held by foreign investors. Interest payment to foreigners are considered as leak out of domestic economy and reduce NI However, this is not a problem of the budget deficit, the problem we need to focus on is trade deficit Example: country with balanced budget/surplus, and large trade deficit (US in 1990 imports>exports) , the difference must be made up by transferring ownership of US based assets to foreign investors (T-bills, equity, debt of firms) but in this case something of value TODAY was enjoyed by US resident (imports>exports ), these residents must have given up claims on income generated TOMORROW

Therefore, trade deficit means current generations are supporting their living standards at the expense of future generations. it is trade deficit, not the budget deficit, that should be the target.

Are budget deficit and trade deficit related? In the early 1980, the story was: large budget deficit leas to trade deficit Budget deficit in economy with no idle resources lead to increase in i% as gov competes with private borrowers for loanable funds. The increase in i% will make dollar dominated assets more attractive and will appreciate $. As $ appreciates, imports will increase and exports will decrease (trade deficit) However, this does not explain why the US has been running sustained trade deficit for almost past two decades Since the early and mid of 1990s, the movement of trade deficit and budget deficit do not coincide nearly enough to make casual link

The role of borrowing in causing the recession and implications for deficit The problem now is deficient private demand(spending on consumption goods, investment goods, and foreign spending on US exports) all cratered in the past year, fallout from the housing bubble and global economic slowdown Low private demand -> no jobs created before recession-> massive job loss In this case, public demand can and should be increased through expansionary fiscal policy (Gov borrowing either by decreasing tax or increasing spending or both) This increase in borrowing injects demand in the economy (directly through G or indirectly by tax cut to increase purchasing power) When gov undertakes expansionary fiscal policy during recession, it is borrowing the time when it is not competing with the provate sector and households Therefore, gov should try to offset what the private sector is doing in regards to building up or running down debt

When the borrowing of the private sector increased during the housing bubble in the early and mid of 2000s, the gov should not have responded with the 2001 and 2003 tax cut that massively increased deficit Many other tools used to target economic stability. For example, caps on leverage at financial institutions to minimize risky lending

Recovering from earlier recession without stimulus package The quickset action to fight recession is to lower short-term interest rate, because fiscal policy requires support from the congress and the president which takes longer time. But lowering i% has long lag time (12-18 months) even in a healthy economy and in today’s situation, even zero interest rate has little effect At this time, the situation is different from the early 1980s and early 1990s recessions both of which caused at least in part by the Fed raising interest rate. Given that the economy entered these recessions with high i%, Fed had lots of room to cut rates

Federal fund rates since 1973

Accidental Stimulus The 1982 and 2001 increased military spending and tax cuts reduced federal revenues by 3.6% and 1.4% of GDP in the two years after their enactment Neither of these tax cuts packages were constructed in a good way if short run recovery was the goal Stimulus spending to be most effective, government should spend money directly on public investments and relief, or enact tax cuts and transfers directed to the households that are the most cash-strapped and therefore the most likely to spend money quickly Neither the 1980s nor 2000s tax cut followed this rule

The tax cuts in the 1980s were enacted while the Fed was raising rates (offset the benefits of the tax cut) Because the 1980s and the 2000s tax cuts were poorly designed as stimulus, they did little for the economy but still continued to add to budget deficit well after the recession was over (they were not temporary response to a crisis) By contrast, the Recovery Act’s direct draw on revenues will have almost entirely wound down by the end of 2011

Thanks