CHAPTER 33

Fiscal Policy, Deficits, and Debt

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 Chapter Contents
Fiscal Policy and the AD-AS Model
Built-in Stability
Evaluating How Expansionary or Contractionary Fiscal Policy Is
Determined
Recent and Projected U.S. Fiscal Policy
Problems, Criticisms, and Complications of Implementing Fiscal
Policy
The U.S. Public Debt
33-2

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 Fiscal Policy
Deliberate changes in:
• Government spending
• Taxes
Designed to:
• Achieve full-employment
• Control inflation
• Encourage economic growth
Discretionary or nondiscretionary 33-3
LO33.1
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 Expansionary Fiscal Policy
Use during a recession:
• Increase government spending
• Decrease taxes
• Combination of both
• Create a deficit

33-4
LO33.1
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 Expansionary Fiscal Policy with the Multiplier Effect
AS
$5 billion initial
Price level increase in spending

P1 Full $20 billion

increase in
aggregate demand

AD2 AD1

0 $490 $510
33-5
LO33.1 Real GDP (billions)
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 Contractionary Fiscal Policy
Use during demand-pull inflation:
• Decrease government spending
• Increase taxes
• Combination of both
• Create a budget surplus

33-6
LO33.1
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 Contractionary Fiscal Policy
AS
$3 billion initial
decrease in
d c spending
P2 b
Price level

Full $12 billion

decrease in
aggregate
demand
P1 a

AD3 AD5 AD4

0 $502 $510 $522

Real GDP (billions)
LO33.1 33-7

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 Built-In Stability
Automatic stabilizers:
• Taxes vary directly with GDP
• Transfers vary inversely with GDP
Economic importance
Tax progressivity:
• Progressive tax system
• Proportional tax system
• Regressive tax system
33-8
LO33.2
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 Built-In Stability

Government expenditures, G,
T

and tax revenues, T

Surplus

G
Deficit

0 GDP1 GDP2 GDP3

Real domestic output, GDP

33-9
LO33.2
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 Evaluating Fiscal Policy
Is the fiscal policy…
• Expansionary?
• Neutral?
• Contractionary?
Use the cyclically adjusted budget to evaluate.

33-10
LO33.3
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 Zero Cyclically Adjusted Deficits, Years 1 and 2
T

Government expenditures, G, and

tax revenues, T (billions)

b a
$500 G

450 c

GDP2 GDP1
(year 2) (year 1)
LO33.3 Real domestic output, GDP 33-11

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 Zero Cyclically Adjusted Deficit, Year 3; $25 Billion
Cyclically Adjusted Deficit, Year 4
T1
T2
Government expenditures, G, and
tax revenues, T (billions)

e d
$500 G
475
h
450 f
425
g

GDP4 GDP3
(year 4) (year 3)
LO33.3 Real domestic output, GDP 33-12

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 Federal Deficits (-) and Surpluses (+)
as Percentages of GDP, 2003-2010
(1) (2) (3)
Year Actual Deficit –or Surplus + Cyclically Adjusted Deficit–or Surplus +
2000 + 2.4 + 1.5
2001 + 1.2 + 1.1
2002 –1.4 –0.8
2003 –3.3 –2.4
2004 –3.4 –2.9
2005 –2.5 –2.3
2006 – 1.8 – 1.9
2007 –1.1 – 1.3
2008 –3.1 – 2.9
2009 –9.3 – 7.6
2010 –8.3 –6.4

33-13
LO33.4
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 Federal Deficits (-) and Surpluses (+)
as Percentages of GDP, 2010-2018
(1) (2) (3)
Year Actual Deficit –or Surplus + Cyclically Adjusted Deficit–or Surplus +
2011 –8.1 – 6.5
2012 –6.6 – 5.3
2013 –4.0 – 2.8
2014 –2.7 – 1.8
2015 –2.4 – 1.9
2016 –3.1 – 2.7
2017 –3.4 – 3.1
2018 – 3.9 – 3.9

33-14
LO33.4
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 Fiscal Policy from 2000 to 2007
Full employment, 2000

Tech stock bubble burst, 2000

Terrorist attack, 2001

Tax cuts, 2002 and 2003

33-15
LO33.4
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 Fiscal Policy: During and after the Great Recession
Financial market problems began in 2007.
Credit market freeze.
Pessimism spreads to the overall economy.
Recession officially began December 2007 and lasted
18 months.
Economy slow to recover.
33-16
LO33.4
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 Problems, Criticisms, and Complications
Problems of timing:
• Recognition lag
• Administrative lag
• Operational lag
Political considerations
Future policy reversals
Offsetting state and local finance
Crowding-out effect 33-17
LO33.5
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 The U.S. Public Debt
$22.1 trillion in April 2019: The accumulation of years
of federal deficits and surpluses.
Owed to the holders of U.S. securities:
• Treasury bills
• Treasury notes
• Treasury bonds
• U.S. savings bonds 33-18
LO33.6
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 Ownership of U.S. Public Debt, 2018

33-19

LO33.6 Sources: Economic Report of the President 2019 and Treasury Bulletin,
©2021 McGraw Hill Education. All rights reserved. No reproduction or further distribution without the prior written consent of McGraw Hill Education. March 2019, U.S. Treasury.
 Federal Debt Held by the Public, Excluding the Federal
Reserve, as a Percentage of GDP, 1970–2018
80

70

60
Percent of GDP

50

40

30

20 Federal debt held by

the public as a
percentage of GDP
10

0
1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 33-20

Year
LO33.6 Sources: Federal Reserve Bank of St. Louis and the U.S. Office of
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 Global Perspective 33.1

33-21

LO33.6
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 The U.S. Public Debt Concerns
Interest charges:
• Primary burden of the debt
• 1.8% of GDP in 2018
False Concerns:
• Bankruptcy
• Refinancing
• Taxation
• Burdening future generations
LO33.6 33-22
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 Substantive Issues
Income distribution
Incentives
Foreign-owned public debt
Crowding-out effect revisited
• Future generations
• Public investment
• Public-private complementarities
LO33.6 33-23
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 Last Word: The Social Security and Medicare Time
Bombs (1 of 2)
More Americans will be receiving benefits as they age.
Social Security shortfalls:
• Income during retirement
• Funds will be depleted by 2033
Medicare shortfalls:
• Medical care during retirement
• Funds will be depleted by 2024 33-24
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 Last Word: ThePossible
Social Security and
Solutions Medicare Time
Bombs (2 of 2)
Possible options “to fix” include:
• Increasing the retirement age.
• Increasing the portion of earnings subject to the
social security tax.
• Disqualifying wealthy individuals.
• Redirecting low-skilled immigrants to higher-skilled,
higher-paying work.
• Defined contribution plans owned by individuals. 33-25
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