Deficits and Debt

Deficit A deficit is a shortfall of incoming revenues vs. spending If revenues exceed spending >Budget Surplus If revenues equal spending >Balanced Budget If spending exceed revenue >Budget Deficit Deficits happen because of overspending, debt payments, war financing, national emergencies, fiscal policy............

National Debt The 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

Two Kinds of Debt External government debt Internal government debt debt owed individuals in foreign nations. Internal government debt debt owed to its own citizens

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

Why Debt is Bad We 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)

How debt is good Access to more then a cash society Can build wealth - ? Drives Growth/expansion “Buy” into system (Social Control)

But....Government debt is different than an individual’s debt. Since government is ongoing, it never has to settle its accounts Governments can pay off debt by creating money. (For a short time) Government can collect taxes to pay the debt Nation has vast assets Americas Role in the World*

Fiscal Policy

Discretionary Fiscal Policy – Those elements of the federal budget that can be changed to counter to the business cycle Taxes Direct Spending Subsidies/Bailouts

Fiscal Policy Deliberate changes in government spending and tax collections to affect: Employment Inflation Economic growth

Two Types of Policy Expansionary Contractionary

Two Types of Policy Expansionary Increase Government Spending/Subsidies Tax Reductions Combinations of the Two Result: Demand for goods grow More people employed Inflation

Two Types of Policy Contractionary Decrease Government Spending/Subsidies Tax Increases Combinations of the Two Result: Demand for goods slows More people unemployed Inflation Less

Types of spending Discretionary spending Government can spend on whatever Non-Discretionary Spending Must be spent on certain programs Can’t change unless laws are changed first.

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 revenue No delay, or lag, because of political controversies, administrative problems

Problems with Using Fiscal Policy Rational Expectations Timing Issues Political Issues Regional Differences

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: TAXES Only applies when people know IN ADVANCE of a policy.

Fiscal Policy Timing Issues Recognition lag Administrative lag Operational lag

Timing Issues- Recognition Lag Time it takes for majority to understand/ acknowledge a problem and pick course of action. (Surveys, Economic Indicators)

Timing Issues Recognition lag Administrative lag Operational lag

Timing Issues- Administrative Lag Time it takes to write and implement the laws/policy to fix the problem

Timing Issues- Operational lag Time it takes for policy to work

Timing Issues Recognition lag Administrative lag Operational lag -3 Months for information to become available. Administrative lag ~3 Months because Federal legislation is required Operational lag ~6-12 Months to see result

The political business cycle The tendency of the political elements of a government to create instability by: Reducing taxes before elections Increasing government spending before elections Raise taxes after elections

Regional Differences Issues will vary from region to region so policy may not work the same all over.

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.

The Federal Reserve System and Monetary Policy

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.

The Federal Reserve System Central Bank Federal Reserve Bank – AKA “The Fed” Quasi-public Agency Has twelve regional privately-owned Federal Reserve Banks Act as fiscal agents for the U.S. Treasury

The Federal Reserve System

Why Have a Central Bank? Activity (Class) Think of some possible reasons for the creation of the Fed?

Why Have a Central Bank? Bank of the Government Central Economic “Authority” Influence Economy Print Money etc. Oversee commercial banks Back-up for regular banking system Confidence/Stability Avoid political influences

Has authority to: Regulate the private banks Make loans to banks (Bankers Bank) Supply money when needed to banks Print Money, Issue Treasury securities Regulate consumer credit system Bank for government agencies Manage exchange rates

How the Federal Reserve Controls the Money Supply Board of Governors Sets Policy Can change the required reserve ratio Can change the discount rate Can engage in open market operations

Required Reserve Ratio Ratio of actual currency to investments banks can have. $100 10% Reserve Ratio = Bank has $90 to invest elsewhere or loan out

The Discount Rate The discount rate is the interest rate that banks pay to the Fed to borrow from it. Increasing interest rates Slows the economy by making loans more expensive Promotes consumer savings > decreases economic activity • Decreasing interest rates Expands the economy by making loans less expensive Promotes consumer spending > Increases economic activity

Open Market Operations When the Federal Reserve buys or sells securities to influence money supply Done by: Federal Open Market Committee (FOMC) Fed will buy money = can lend more money cheaply > money supply expands Fed will sell money = less money to lend so more expensive > money supply contracts (FOMC)

Open Market Operations Open market operations are the Fed’s preferred means of controlling the money supply because: More precise Extremely flexible Fairly predictable

Transmission Lags The time between a change in interest rates and when an effect is felt in the economy A typical lag time is 6 to 12 months