Macroeconomics James B. Wilcox RESOURCES PROVIDED BY: THE UNIVERSITY OF SOUTHERN MISSISSIPPI CENTER FOR ECONOMIC AND ENTREPRENEURSHIP EDUCATION, MISSISSIPPI STATE UNIVERSITY, & VIRTUAL ECONOMICS

Economics… is the study of how individuals and society choose, with or without the use of money, to employ scarce productive resources to produce various commodities over time and distribute them for consumption, now and in the future, among various people and groups in a society.

Introduction to Macroeconomics

Macroeconomics Macro is the study of: 4 important variables: The structure and performance of a national economy 4 important variables: 1. GDP Gross Domestic Product 2. P the price level 3. UNE national unemployment rate 4. r interest rate

U.S. Macro Economy Very complicated 95 million households 20 million firms 80 thousand governments

Macro Terms Stock: Flow: A quantity at a point in time A quantity during a period of time

Macro Terms GDP, (Y) Gross Domestic Product: Potential GDP (YN): Value of total production of all final goods and services during a period of time Flow variable Potential GDP (YN): The economy’s maximum sustainable output when resources are allocated efficiently not over-utilized nor under-utilized

Macro Terms Unemployment types Frictional – voluntary unemployment that arises because of the time needed to match job seekers with job openings Structural – unemployment caused by massive mismatch of skills or geographic location Seasonal – unemployment caused by seasonal changes in labor supply and demand during the year Cyclical – unemployment that is incurred by business cycles, or more specifically by economic recessions

GDP Final Outputs GDP consists of only: GDP does not include: Final goods and services GDP does not include: 1. Intermediate outputs in order to avoid over-counting Intermediate outputs are used as inputs to make final outputs e.g. capital goods 2. Used goods they were counted the first time they were purchased 3. Financial assets e.g. stocks, bonds

Which of the following is an example of an intermediate good? A pair of jeans sold by a clothing retailer Cloth sold to a suit manufacturer A share of Wal-Mart stock A used Ford Mustang sold from one neighbor to another

Which of the following is an example of an intermediate good? A pair of jeans sold by a clothing retailer Cloth sold to a suit manufacturer A share of Wal-Mart stock A used Ford Mustang sold from one neighbor to another

Limitations of Real GDP Real GDP is used to: Estimate the speed at which the economy is moving Does not count: Non-market activities Things that are not priced E.g., Household production, underground economy

If individuals were paid for their household production, GDP would increase decrease Not change Not enough information

If individuals were paid for their household production, GDP would increase decrease Not change Not enough information

Limitations of Real GDP GDP is not a perfect measure of the welfare of a nation: It does not include measures of: Quality of life Leisure time Conditions of environment

Limitations of Real GDP Robert Kennedy 1968 Presidential bid: “[GDP] does not allow for the health of our children, the quality of their education, or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials. It measures neither our courage, nor our wisdom, nor our devotion to our country. It measures everything, in short, except that which makes life worthwhile, and it can tell us everything about America except why we are proud that we are Americans.”

Limitations of Real GDP GDP doesn’t measure many things, but nations with greater GDP can afford…… better health care for their children better educational system to teach more people to read and enjoy poetry Intelligence, integrity, courage, wisdom, devotion to country are easier to foster when people are less concerned about affording basic necessities. We conclude that GDP is a good measure of welfare for most, but not all, purposes

GDP and Standard of Living International data leave no doubt that a nation’s GDP is closely associated with its citizens’ standard of living Use per capita GDP when comparing across nations Per capita GDP = GDP/population

GDP = AE = AI Aggregate Expenditures (AE): The total amount that buyers pay for the final goods and services produced Everything a firm receives from the sale of its output is paid out as income to the resource owner (AI): Wages go to labor owners Rent goes to land owners Interest goes to capital owners Profit goes to owners of entrepreneurial ability

GDP = AE = AI The buyers of GDP The sellers of GDP Therefore, pay an amount equal to aggregate expenditures (AE) The sellers of GDP receive an amount equal to aggregate income (AI) Therefore, GDP = AE = AI For an economy as a whole Income must equal expenditure For every transaction there is a buyer and a seller

Calculating Real GDP 3 ways to calculate GDP: 1. Expenditure approach 2. Factor Income approach 3. Value Added approach We will use the expenditure approach GDP = C + I + G + NX C, personal consumption expenditure I, gross private investment expenditure G, government expenditure NX, net export expenditure

Consumption Expenditure, C Consumption, C Spending by households on new goods and services, with the exception of new housing e.g. Purchases of food, clothing, services, autos, other durable goods like furniture

Gross Investment Expenditure, I Investment, I Spending on capital equipment, inventories, and structures including household purchases of new housing Nonresidential investment E.g. machinery, equipment, factories, warehouses, offices purchased by firms Residential investment purchases of newly built homes Inventory change firms’ accumulation of their output

Newly constructed residential housing Factory buildings Which of the following is NOT included in the investment category under the expenditure approach to GDP accounting? Newly constructed residential housing Factory buildings Stocks and bonds Additions to inventory All of the above are included in investment

Newly constructed residential housing Factory buildings Which of the following is NOT included in the investment category under the expenditure approach to GDP accounting? Newly constructed residential housing Factory buildings Stocks and bonds Additions to inventory All of the above are included in investment

Government expenditures Net exports Residential construction is generally included in which category of GDP? consumption investment Government expenditures Net exports

Government expenditures Net exports Residential construction is generally included in which category of GDP? consumption investment Government expenditures Net exports

Government Expenditure, G Government, G Spending on goods and services by local, state, and federal governments E.g., salaries, computers, military hardware, etc. Does NOT include transfer payments like social security, welfare, etc.

Government purchases include all of the following except: Welfare payments Salaries of senators Fighter jets purchased by the government The military payroll

Government purchases include all of the following except: Welfare payments Salaries of senators Fighter jets purchased by the government The military payroll

Net Export Expenditure, NX Net Exports, NX Spending by foreigners on domestically produced goods (exports) minus spending by domestic residents on foreign goods (imports) Net Exports (NX)= Exports (X)- Imports (M) If M > X => NX are negative, I.e. trade deficit Americans spent more on foreign goods and services than foreigners spent on American goods and services

Net Export Expenditure, NX Purchases of foreign goods and services are included in C, I, G E.g. American spending on a Volvo (Swedish car) is included in C We minus imports because we are trying to get a measure of domestic activity

Net exports are defined as Exports plus imports Exports minus imports Imports minus exports Exports plus imports minus tariffs

Net exports are defined as Exports plus imports Exports minus imports Imports minus exports Exports plus imports minus tariffs

Consumption is the largest single component of GDP Consumption is the largest single component of GDP. In recent years it represents approximately _____ % of GDP. 55 60 65 70 75

Consumption is the largest single component of GDP Consumption is the largest single component of GDP. In recent years it represents approximately _____ % of GDP. 55 60 65 70 75

GDP Components

GDP Estimates Estimates are constantly Advance estimates: being revised Advance estimates: released 15 days after the quarter ends and are based on only the first month of the quarter Preliminary estimates: first revision, 45 days after the end of the quarter Final estimates: second revision, 75 days after the end of the quarter

GDP Estimates Annual estimates: Benchmark estimates: numbers are then revised once a year for two years Benchmark estimates: revisions made every 5 years

GDP Estimates The media focuses on: Advance estimates Range of revisions can result in changes ranging from –2.5 % points to +3.5% points from advance estimates until benchmark estimates

GDP Estimates If advance estimates show a 3% annualized growth rate in real GDP, find the range of actual real GDP once all revisions are made: Lower bound: 3% - 2.5% = .5% actual annualized growth rate Upper bound: 3% + 3.5% = 6.5% actual annualized growth rate Serious implications for policy makers

Saving, Investment, and Financial Intermediaries

Making the Connection Learning Objective 21.2 Ebenezer Scrooge: Accidental Promoter of Economic Growth? Who was better for economic growth: Scrooge the saver or Scrooge the spender?

Who was better for the economy? Scrooge the saver Scrooge the spender

Who was better for the economy? Scrooge the saver best for long run economic growth Scrooge the spender best if we are in a recession

“Saving” U.S. vs Japanese savings rates When a person earns more than he spends Individuals can deposit the unspent income into a bank, or buy a bond or some stock Individuals often refer to this activity as “investing” However, macroeconomists call this “saving” U.S. vs Japanese savings rates

“Investment” Investment Examples of investment Purchase of new capital Equipment or buildings Examples of investment An individual who borrows to finance building a new house A firm sells some stock to build a new factory

S = I For the macroeconomy as a whole Recall that GDP equals Saving (S) must equal investment (I) Recall that GDP equals Y = C + I + G + NX Assume the economy is closed so that NX = 0 Y = C + I + G Each unit of output sold in a closed economy is consumed, invested, or bought by the government

S = I To emphasize the link between saving and investment, You get, subtract C and G from both sides You get, Y – C - G = I Y – C – G is the total income in the economy that remains after paying for consumption and government purchases i.e., national saving, S Which leaves, S = I

Financial Institutions The financial system is made up of institutions that Coordinate individuals who are saving and individuals who are investing Savers supply their money to the financial system With the expectation of earning interest Borrowers demand funds from the financial system Knowing they will be required to pay it back with interest

Financial Markets Bond Market Promise to pay back a loan Large corporations can borrow money directly from the public by selling bonds The person who buys the bond gives money to the firm Firm uses the funds to expand their business This is called debt financing The buyer can either hold the bond until maturity can sell the bond to someone else

Financial Markets Stock Market Represents ownership in a firm Stockholders own the company Thus, they own the profits or losses Stocks are riskier than bonds Pay a higher rate of return Firms can sell stock in order to raise funds to expand This is called equity financing

Financial Markets Stock Market After the firm issues the stock The shares are traded on organized stock exchanges NYSE, NASDAQ, AMSE Corporations themselves do not earn anything from the trades Prices of stocks are determined by the demand and supply for each one Reflects the beliefs about the value of a company Stock index A computed average of a group of stock prices Dow Jones Industrial Average--30 major U.S. companies Standard and Poor’s—500 major companies

Financial Intermediaries Banks In order to borrow funds, most firms must use banks Only the largest and most widely recognized firms can borrow funds through bonds and stocks Banks Take deposits from people who are saving and pay them an interest rate Give loans to those who are borrowing and charge them an interest rate The difference in the interest rate paid out and charged provides profits to the bank owners

Financial Intermediaries Mutual Funds An institution that sells shares to the public and buys a portfolio of stocks and bonds Many different types of stocks and bonds Enables savers to Diversify Lowering risk Receive services of professional money managers Index fund A fund that buys all the stocks in a given stock index

Market for Loanable Funds Because the economy has many types of financial institutions There are many different interest rates All are determined through the demand and supply of funds Assume for simplicity that there is just one market for loanable funds All savers go to this market to deposit saving All borrows go to this market in order to invest

Supply of Loanable Funds The source of the supply of loanable funds is Saving At higher interest rates Saving is more attractive The quantity saved increases At lower interest rates Saving is less attractive The quantity saved decreases

Demand for Loanable Funds The source of the demand of loanable funds is Borrowing I.e., investment At higher interest rates borrowing is less attractive The quantity borrowed and invested decreases At lower interest rates borrowing is more attractive The quantity borrowed and invested increases

Equilibrium Real Interest Rate, rr* The equilibrium real interest rate occurs where the supply and demand for loanable funds intersects If the interest rate were lower than rr* There would be a shortage of loanable funds Lenders would be scarce and borrowers plentiful Increasing the interest rate If the interest rate were higher than rr* There would be a surplus of loanable funds Lenders would be plentiful and borrowers would be scarce Decreasing the interest rate

Invisible Hand Financial markets In this case work much like other markets In this case Saving represents the supply of loanable funds Investment represents the demand for loanable funds Interest rate adjust to balance the supply and demand in the market for loanable funds

Government Policy to Increase Saving Taxes on saving Lower saving for every given interest rate If the government decided to reduce taxes on saving The incentive to save would increase for every given interest rate 1. Increase the supply of saving curve 2. Reduce the equilibrium interest rate 3. Increase the level of investment

Government Policy to Increase Investment Giving firms an investment tax credit would Encourage more firms to borrow and invest in new capital for every given interest rate 1. Increase the demand for investment 2. Increase the interest rate 3. Increase the amount of saving

Inflation

Macro Terms Average (Aggregate) Price Level, P: Inflation: Nominal: The average price of all outputs Absolute concept, not relative Inflation: Process of rising prices Nominal: NOT adjusted for inflation “current dollars” Real: Adjusted for inflation “constant dollars”

Macro Terms Hyperinflation: Deflation: Disinflation: Inflation that exceeds 50% a month Deflation: Process of falling prices Disinflation: Slowing of inflation

Real v. Nominal GDP Nominal GDP: Real GDP: GDP valued in current dollars not adjusted for inflation Real GDP: GDP valued in constant dollars adjusted for inflation More informative than nominal often compared across time

Business Cycles

Macro Terms Business Cycle: Recession: Depression: Expansion: Shows fluctuations in GDP around potential GDP Recession: Real GDP decreases for at least two successive quarters associated with rising unemployment, falling profits and income Depression: Extremely severe decline in real GDP Expansion: Rising real GDP associated with falling unemployment, higher profits and income

The Business Cycle Peak REAL GDP Expansion Recession Trough TIME ACTIVITY Which point on the business cycle is the best match for the description of the economy in your scenario? Instructions: Split audience into 4 to 8 groups of 3-4 people. Distribute a copies of one scenario to the group (Points A, B, C, or D) so that each person has a copy of his or her group’s point. You will need to give one scenario to more than one group, if you have more than four groups. Ask each group to consider it’s business cycle point and identify if the group’s point describes a peak, recession, trough, or expansion. Ask one group member from each group to tape the group’s scenario on the appropriate point on the business cycle poster. Discuss answers. Trough TIME

Y and YN

What We Learn From GDP By looking at the graph, we learn that: 1. real GDP grows over time output of goods and services has grown over time averaging about 3% per year allows the typical American to enjoy greater prosperity than his/her parents and grandparents 2. growth is not steady upward climb is occasionally interrupted by periods of decline Macroeconomics is about explaining both--the long-run trends and the short-run fluctuations

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Activity 17

Money and Monetary Policy FEDERAL RESERVE SYSTEM TOOLS OF THE FED EXPANSIONARY MONETARY POLICY CONTRACTIONARY MONETARY POLICY POLICY DEBATES

The Federal Reserve was established in 1913 to Prevent inflation by decreasing the money supply Stimulate the economy by increasing bank reserves Stop bank panics by acting as a lender of last resort Prevent bad loans by requiring banks to hold reserves

The Federal Reserve was established in 1913 to Prevent inflation by decreasing the money supply Stimulate the economy by increasing bank reserves Stop bank panics by acting as a lender of last resort Prevent bad loans by requiring banks to hold reserves

Which of the following is not a function of the “Fed”? Acting as lender of last resort Acting as a banker’s bank Performing check clearing services Insuring deposits in the banking system Taking actions to control the money supply

Which of the following is not a function of the “Fed”? Acting as lender of last resort Acting as a banker’s bank Performing check clearing services Insuring deposits in the banking system Taking actions to control the money supply

Federal Reserve System The Fed Is a special kind of bank a bank for banks The Fed acts as a central banking system with centralized economic power The Fed’s job: Is to manage the money supply in what it perceives to be the national interest

Federal Reserve System Fed was established in 1913 Very recent Federal Reserve System is made up of 12 central banks, each with its own region The Fed is run by a 7 member Board of Governors Appointed by the President and confirmed by the Senate 14 year terms President designates a chairman for a 4 year term Headquartered in Washington, D. C.

Federal Reserve System Once appointed, the governors are independent of the rest of government This is to give the Fed the ability to make decisions on objective, technical criteria rather than on political agendas

FOMC Federal Open Market Committee, FOMC: FOMC has 12 members: Works with the Board of Governors and largely determines the size of the U.S. money supply FOMC has 12 members: 7 governors 5 presidents of district banks FOMC meets every six weeks Policy implementation is normally done through the New York Fed Bank

Money

Liquidity Liquidity An asset is completely “liquid” if The ease of an asset’s ability to be converted to cash An asset is completely “liquid” if one can spend it now

Definitions of the Money Supply There are 3 measures of the money supply M1 The most liquid of all definitions of the money supply M2 M3 Currency held by banks in the form of reserves is NOT counted as part of the money supply because it is not available for individuals to make purchases with

Definitions of the Money Supply Sum of all currency, coin, traveler’s checks in the hands of the public 30% Sum of all of the most liquid checking accounts 70% M2= M1 + savings accounts, money market mutual funds, small time deposits (cd’s < 100,000) M3= M1 + M2 + large time deposits

Which of the following assets is most liquid? money bond savings account stock

Which of the following assets is most liquid? money bond savings account stock

Money Creation Process

Banks hold 100% of their checking deposits as vault cash to ensure that bank runs do not occur. True False

Banks hold 100% of their checking deposits as vault cash to ensure that bank runs do not occur. True False

Money Creation Process Fractional Reserve Banking System: Banks keep only part of all its deposits When a bank gets a new deposit: it keeps a portion of it in reserves and then lends out the rest Individuals and firms receiving the loans then deposit their loan checks into their banks Those banks: repeat the process by keeping a portion of the deposit and then lending out the rest Hence, a fractional reserve system creates money i.e., increases the money supply

Which of the following best describes how banks create money? Banks charge higher interest rates on loans than they pay on deposits Banks charge fees for providing financial advice Banks create checking account deposits when making loans from excess reserves Banks make loans from reserves

Which of the following best describes how banks create money? Banks charge higher interest rates on loans than they pay on deposits Banks charge fees for providing financial advice Banks create checking account deposits when making loans from excess reserves Banks make loans from reserves

Tools of the Federal Reserve

The Fed directly controls the interest rate and inflation rate. True False

The Fed directly controls the interest rate and inflation rate. True False

Tools of the Fed The Fed uses 3 tools to control the money supply 1. Open market operations 2. Required reserve ratio 3. Discount rate

RRR The Fed If the Fed increases the RRR If the Fed decreases the RRR sets the RRR If the Fed increases the RRR Banks are required to hold more of their deposits decreasing the money supply If the Fed decreases the RRR Banks are free to lend out more of their deposits increasing the money supply

Discount Rate Discount Rate If the Fed increases the discount rate the interest rate that individual banks pay to the Fed in order to borrow funds If the Fed increases the discount rate It is more expensive to borrow from the Fed banks tend to hold more excess reserves decreasing the money supply If the Fed decreases the discount rate It is less expensive to borrow from the Fed banks tend to hold fewer excess reserves increasing the money supply

OMO Open Market If the Fed sells government securities: financial marketplace made up of non-government sectors If the Fed sells government securities: Individuals and firms begin to buy them from the Fed Money goes from the open market (in the Ms) to the Fed (out of the Ms) The money supply falls If the Fed buys government securities: Individuals and firms begin to sell them to the Fed Money goes from the Fed (out of the Ms) to the open market (in of the Ms) The money supply increases

Interest rates, tax rates, and government spending The three main monetary policy tools used by the Fed to manage the money supply are Interest rates, tax rates, and government spending Tax rates, government purchases, and transfer payments Open market operations, discount policy, and reserve requirements Open market operations, the exchange rate, and government purchases

Interest rates, tax rates, and government spending The three main monetary policy tools used by the Fed to manage the money supply are Interest rates, tax rates, and government spending Tax rates, government purchases, and transfer payments Open market operations, discount policy, and reserve requirements Open market operations, the exchange rate, and government purchases

Expansionary Monetary Policy The Fed can increase the Ms by doing the following Buying government bonds Decreasing the RRR Decreasing the discount rate

Contractionary Monetary Policy The Fed can decrease the Ms by doing the following Selling government bonds Increasing the RRR Increasing the discount rate

Expansionary monetary policy refers to the _____ to increase real GDP. Government’s increasing spending and lowering taxes Government’s decreasing spending and raising taxes Federal Reserve’s increasing the money supply and decreasing interest rates Federal Reserve’s decreasing the money supply and increasing interest rates

Expansionary monetary policy refers to the _____ to increase real GDP. Government’s increasing spending and lowering taxes Government’s decreasing spending and raising taxes Federal Reserve’s increasing the money supply and decreasing interest rates Federal Reserve’s decreasing the money supply and increasing interest rates

Which of the following is true about the Fed’s ability to prevent recessions? The Fed Does not try to eliminate recessions, but instead focuses on preventing inflation Can fine tune the economy and realistically hope to keep the economy from experiencing recessions Cannot realistically fine tune the economy, but seeks to keep recessions shorter and milder than they would otherwise be Cannot realistically fine tune the economy and has little to no effect on the magnitude and length of recessions

Which of the following is true about the Fed’s ability to prevent recessions? The Fed Does not try to eliminate recessions, but instead focuses on preventing inflation Can fine tune the economy and realistically hope to keep the economy from experiencing recessions Cannot realistically fine tune the economy, but seeks to keep recessions shorter and milder than they would otherwise be Cannot realistically fine tune the economy and has little to no effect on the magnitude and length of recessions

Should Policymakers Try to Stabilize the Economy?

Yes, Policymakers Should Stabilize Argument: Economies fluctuate on their own and there is no reason to suffer through booms and busts Recession lead to lower real GDP and higher unemployment Expansions lead to higher inflation During a recession policymakers should Increase government spending, cut taxes, and expand the money supply During an expansion policymakers should Decrease government spending, raise taxes, and decrease the money supply

No, Policymakers Should Not Stabilize Argument: Allow the economy to heal itself and “do no harm” Substantial obstacles to the effective use of policy changes to influence the economy Time lags can be anywhere from 6 months to several years Policymakers need accurate information on the future of the economy to make accurate policy changes Economic forecasts are imprecise Policy changes can make matters worse

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FISCAL POLICY AND DEMAND SUPPLY-SIDE ECONOMICS

Fiscal Policy Fiscal Policy This use of fiscal policy came The use of the federal budget to achieve macro goals full employment sustained economic growth price level stability This use of fiscal policy came after the Great Depression of the 1930’s and the thinking of John Maynard Keynes Prior to that, governments allowed the economy to regulate itself the federal budget was used only to finance the activities of the federal government

Tools of Fiscal Policy 3 tools of fiscal policy To analyze each one G Taxes Transfers To analyze each one Hold everything else constant Changes in G Expansionary Contractionary

Fiscal Policy and AD Changes in Taxes Changes in Transfers DI = Income – taxes + transfers Expansionary Contractionary Changes in Transfers

The Effects of Fiscal Policy on Real GDP and the Price Level Learning Objective 15.2 The Effects of Fiscal Policy on Real GDP and the Price Level Table 15-1 Countercyclical Fiscal Policy PROBLEM TYPE OF POLICY ACTIONS BY CONGRESS AND THE PRESIDENT RESULT Recession Expansionary Increase government spending or cut taxes Real GDP and the price level rise. Rising Inflation Contractionary Decrease government spending or raise taxes Real GDP and the price level fall. Don’t Let This Happen to YOU! Don’t Confuse Fiscal Policy and Monetary Policy

Increases; increases Increases; decreases Decreases; increases An increase in individual income taxes _____ disposable income, which _____ consumption spending. Increases; increases Increases; decreases Decreases; increases Decreases; decreases

Increases; increases Increases; decreases Decreases; increases An increase in individual income taxes _____ disposable income, which _____ consumption spending. Increases; increases Increases; decreases Decreases; increases Decreases; decreases

The money supply and a decrease in interest rates Government purchases If the economy is falling below potential real GDP, which of the following would be an appropriate fiscal policy? An increase in The money supply and a decrease in interest rates Government purchases Oil prices Taxes

The money supply and a decrease in interest rates Government purchases If the economy is falling below potential real GDP, which of the following would be an appropriate fiscal policy? An increase in The money supply and a decrease in interest rates Government purchases Oil prices Taxes

A decrease in the money supply and an increase in the interest rate If real GDP exceeded potential real GDP and inflation was increasing, which of the following would be an appropriate fiscal policy? A decrease in the money supply and an increase in the interest rate An increase in government spending An increase in taxes An increase in oil prices

A decrease in the money supply and an increase in the interest rate If real GDP exceeded potential real GDP and inflation was increasing, which of the following would be an appropriate fiscal policy? A decrease in the money supply and an increase in the interest rate An increase in government spending An increase in taxes An increase in oil prices

Fiscal Policy and Aggregate Supply

Fiscal Policy and Aggregate Supply “Supply-side economics” Attempts to increase YN, potential real GDP Taxes create Disincentives which decrease potential real GDP So, lower income taxes Strengthens the incentive to work Increases aggregate supply

Marginal Tax Rates Marginal tax rates of the richest Americans: Carter 50% Reagan 28% Bush 31% Clinton 39.6% W. Bush 35%

Fiscal Policy and Aggregate Supply Tax policies encouraging I Lead to higher stocks of capital Increases aggregate supply Tax relief for firms in R & D Encourage new technology

Supply-Side Economics and Aggregate Demand However, lowering taxes and increasing investment Also increase AD

Supply-Side Economics Supply-side is largely effective in the SR because of its effects on Aggregate Demand Supply-side economics is largely effective in the LR because of its effects on Aggregate Supply

Which of the following would be classified as fiscal policy? The federal government passes tax cuts to encourage firms to reduce air pollution The Federal Reserve cuts interest rates to stimulate the economy A state government cuts taxes to help the economy of the state The federal government cuts taxes to stimulate the economy

Which of the following would be classified as fiscal policy? The federal government passes tax cuts to encourage firms to reduce air pollution The Federal Reserve cuts interest rates to stimulate the economy A state government cuts taxes to help the economy of the state The federal government cuts taxes to stimulate the economy

Which of the following best describes supply-side economics? Labor productivity impacts aggregate supply Education impacts labor productivity which impacts aggregate supply Education impacts the incentive to work, save, and invest, and therefore aggregate supply Tax rates, particularly marginal tax rates, affect the incentive to work, save, and invest, and therefore aggregate supply

Which of the following best describes supply-side economics? Labor productivity impacts aggregate supply Education impacts labor productivity which impacts aggregate supply Education impacts the incentive to work, save, and invest, and therefore aggregate supply Tax rates, particularly marginal tax rates, affect the incentive to work, save, and invest, and therefore aggregate supply

Activities 30 / 31

Should We Worry About the National Debt?

If we took all of our nation’s income and paid off the national debt, how long will it take? More than 10 years Five years Two years One year Less than one year

If we took all of our nation’s income and paid off the national debt, how long will it take? More than 10 years Five years Two years One year Less than one year

Federal Budget Deficit/Surplus A deficit (or surplus) is a Debt is a Revenues > Expenditures surplus Expenditures > Revenues deficit A deficit (or surplus) is a flow variable Debt is a stock variable Government debt is sold by issuing bonds Treasury “T” bills to the public

The Federal Budget Deficit Learning Objective 15.5 The Federal Budget Deficit FIGURE 15.13 The Federal Budget Deficit, 1901–2006

Reasons NOT to worry about the debt The following work to “reduce” the figures 1. Take figures in relation to GDP 2. Adjust for state and local surpluses and debt owned by government “Net public debt” 3. Adjust for the cyclical component of the economy 4. Adjusting for capital outlays It is normal for capital outlays to grow in a growing economy 5. Adjusting for inflation

Federal Government Debt Learning Objective 15.5 Federal Government Debt

Current Debt The current debt is $11.9 trillion dollars $4.4 trillion is held by government agencies Therefore, the U.S. net public debt is about $7.6 trillion Nominal GDP is about $14.2 trillion In other words, net public debt makes up 53.5% of GDP If we used all of the nation’s resources to pay off the debt alone, how long would it take to pay it off? About 7 months

Should we worry about the debt? The cause of the debt is important to whether it is a burden Until the 1980’s most debt was acquired because of war or recession These are taken to be good reasons to incur debt 1980’s and 1990’s and early 2000s have seen rising structural deficits due to expansionary policy Cause for concern for incurring debt

Reasons TO worry about the debt 1. The ensuing inflation 2. Effects on Investment A deficit is negative saving Supply of national saving decreases Increasing the interest rate Some private investment is “crowded out” The “I” in GDP Leads to lower capital stock, K, in the future Lower productivity and standard of living

Reasons TO worry about the debt 3. Borrowing from abroad About 40% of net public debt is held by foreigners The higher interest rates encourage more investment in the U.S. by foreigners The higher interest rates cause the dollar to appreciate Twin deficits 4. Growth of interest payments Opportunity cost

Should the Federal Government Have a Yearly Balanced Budget?

State of the Economy on Deficits Larger deficits do not always mean the government has undertaken expansionary fiscal policy The same fiscal policies can lead to large or small deficits depending on the state of the economy With no change in policy: Recessions increase deficits Expansions decrease deficits

State of the Economy on Deficits Recessionary Gap Tax revenues fall Transfer payments rise =>Deficits increase Under a yearly balanced budget, gov’t expenditures must: Decrease, making the gap worse

State of the Economy on Deficits Expansionary Gap Tax revenues rise Transfer payments fall =>Deficits decrease Under a yearly balanced budget, gov’t expenditures must: Increase, making the gap worse “boom the boom”

State of the Economy on Deficits Economists prefer using the structural deficit rather than the actual deficit Structural deficit is based on what expenditures would be if the economy were at full employment changes as policy changes, not as the economy changes If the goal is a balanced budget The structural deficit should be balanced over the business cycle

Increase; rise; fall Increase; fall; rise Decrease; rise; fall A recession tends to cause the federal budget deficit to _____ b/c tax revenues _____ and government spending on transfer payments _____. Increase; rise; fall Increase; fall; rise Decrease; rise; fall Decrease; fall; rise

Increase; rise; fall Increase; fall; rise Decrease; rise; fall A recession tends to cause the federal budget deficit to _____ b/c tax revenues _____ and government spending on transfer payments _____. Increase; rise; fall Increase; fall; rise Decrease; rise; fall Decrease; fall; rise

Macroeconomics James B. Wilcox RESOURCES PROVIDED BY: THE UNIVERSITY OF SOUTHERN MISSISSIPPI CENTER FOR ECONOMIC AND ENTREPRENEURSHIP EDUCATION, MISSISSIPPI STATE UNIVERSITY, & VIRTUAL ECONOMICS