Chapter 13 - Money and banking. This chapter include objectives: The four jobs of money, what money is, M1, M2, and M3, the demand for money, the origins of banking, the creation and destruction of money, branch banking and bank chartering, the FDIC, the savings and loan debacle.
Chapter 12 Fiscal Policy and the National Debt Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 121 Chapter Objectives • • • • • • • The deflationary gap The inflationary gap The multiplier and its applications Automatic stabilizers Discretionary fiscal policy Budget deficits and surpluses The public debt Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 122 Fiscal Policy • Fiscal policy is the manipulation of the federal budget to attain price stability, relatively full employment, and a satisfactory rate of economic growth – To attain these goals, the government must manipulate its spending and taxes Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 123 Putting Fiscal Policy into Perspective • There was no such thing as fiscal policy until John Maynard Keynes invented it in the 1930s – He maintained that • The only way out of the Depression was to boost aggregate demand by increasing government spending • If we ran a big enough budget deficit, we could jumpstart the economy and, in effect, spend our way out of the depression Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 124 Putting Fiscal Policy into Perspective • It’s important that the aggregate supply of goods and services equals the aggregate demand for goods and services at just the level of spending that will bring about full employment at stable prices Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 125 Putting Fiscal Policy into Perspective • Equilibrium GDP tells us the level of spending in the economy • Fullemployment GDP tells us the level of spending necessary to get the unemployment rate down to 5% (which we have been calling fullemployment) • Fiscal policy is used to push equilibrium GDP toward fullemployment GDP Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 126 The Deflationary Gap and the Inflationary Gap • Equilibrium GDP is the level of output at which aggregate demand equals aggregate supply – Aggregate demand is the sum of all expenditures for goods and services (that is, C + I + G + Xn) – Aggregate supply is the nation’s total output of final goods and services – So at equilibrium GDP, everything produced is sold Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 127 The Deflationary Gap and the Inflationary Gap • Fullemployment GDP is the level of spending necessary to provide full employment of our resources – If our plant and equipment is operating at between 85 and 90% of capacity, that’s full employment – If only 5% of our labor force is unemployed, that’s full employment Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 128 The Deflationary Gap & the Inflationary Gap The Deflationary Gap When the fullemployment GDP is greater than the equilibrium GDP, there is a deflationary gap. How much is it? Deflationary gap C + I + G + Xn $1 trillion 2 Equilibrium GDP Full-employment GDP GDP (in trillions of dollars) Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 129 The Deflationary Gap & the Inflationary Gap The Inflationary Gap When equilibrium GDP is greater than full employment GDP, there is an inflationary gap. How large is it? 2,000 C + I + G + Xn Inflationary gap 1,500 1,000 500 $200 trillion 500 500 1,000 1,500 Full-employment GDP 2,000 Equilibrium GDP GDP (in trillions of dollars) Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 1210 The Deficit Dilemma Deficits and Surpluses: The Record The Federal Budget Deficit, Fiscal Years 19702001 Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 1238 Why Are Large Deficits So Bad? • Large deficits raise interest rates, which, in turn, discourages investment – Our real interest rate (the nominal interest rate less the rate of inflation) during the latter half of the 1980s and all of the 1990s was three times a high as the real interest rate in Japan’ and it was much higher than those in most Western European countries as well Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 1239 Why Are Large Deficits So Bad? • The federal government has become increasingly dependent on foreign savers to finance the deficit – In the early – and mid – 1990s foreigners financed more than half the deficit Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 1240 Why Are Large Deficits So Bad? • Until the mid1990s the deficit sopped up more than half the personal savings in this country, making that much less savings available to large corporate borrowers seeking funds for new plant and equipment Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 1241 Why Are Large Deficits So Bad? • On the positive side, budget deficits stimulate the economy – The only problem is that we should not have needed this stimulus during the “prosperous” midto late 1980s when we were running huge deficits – We would do well to remember that John Maynard Keynes would have advocated running surpluses and paying off the debt during periods of prosperity Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 1242 Will We Be Able to Balance Future Budgets? • The federal government finally managed to run a budget surplus in 1998 – This was the first time since 1969 • The congressional Budget Office forecasts a string of surpluses well into the new millennium – Congressional Republicans and Democrats have already proposed dueling plans to dispose of those surpluses with various combinations of tax cuts and spending increases – No elected official proposed slowing down the projected increases in Social Security spending Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 1243 Will We Be Able to Balance Future Budgets? • A recession, a decline in stock prices, a tax cut, or an increase in government spending programs can easily eliminate any surpluses and replace them with deficits • After the year 2015, as the baby boom generation attains senior citizenship, the Social Security Trust Fund will be quickly depleted – Unless the government has already raised Social Security taxes or cut benefits, the federal budget surplus will quickly become a large and growing deficit Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 1244 The Proposed Balanced Budget Amendment and the Line Item Veto • Must we balance the budget each year? – The government really tried to balance the budget each year into the early 1930s – The economic wisdom today tells us that we should have deficits in lean years and surpluses in fat years • From 1961 through 1997 the government managed only one surplus • The national debt rose every year as we ran budget deficits in fat years Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 1245 The Proposed Balanced Budget Amendment and the Line Item Veto • The first step in passing a Constitutional amendment to balance the budget is a twothirds vote in both houses of Congress – Despite some very close votes in 1994, 1995, 1996, and 1997, the balanced budget amendment failed in one or the other houses of Congress – Most economists oppose such an amendment because it would put us in an economic straitjacket Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 1246 The Proposed Balanced Budget Amendment and the Line Item Veto • In still another effort to lower the deficit, Congress passed a law in 1996 to permit the president to veto parts of tax and spending bills, he or she opposes, without vetoing the entire legislation – This line item veto can be eventually overridden by a twothirds vote in each house of Congress – In February, 1998, a federal judge ruled the line item veto unconstitutional Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 1247 The Public Debt • Differentiating between the Deficit and the Debt – The deficit occurs when federal government spending is greater than tax revenue – The debt is the cumulative total of all the federal budget deficits less any surpluses • Suppose that our deficit declined one year from $200 billion to $150 billion • The national debt would still go up by $150 billion • So every year that we have a deficit – even a declining one – the national debt will go up Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 1248 The Public Debt National Debt, 19752000 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 Economic Report of the President, 2000 Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 1249 The Public Debt • Who holds the national debt? – Private American citizens hold a little less than half – Foreigners hold almost onethird – The rest is held by banks, other business firms, and U.S. government agencies • Is the national debt a burden that will have to borne by future generations? – As long as we owe it to ourselves, the answer is no – If we did owe it mainly to foreigners, and if they wanted it paid off, it could be a great burden Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 1250 The Public Debt • When do we have to pay off the debt? – We don’t. All we have to do is roll it over, or refinance it, as it falls due – Each year several hundred billion dollars worth of federal securities fall due • By selling new ones, the Treasury keeps us going – In the future, even if we never pay back one penny of the debt, our children and our grandchildren will have to pay hundreds of billions of dollars in interest • At least to that degree, the public debt will be a burden to future generations Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 1251 The Public Debt • Why not go ahead and just pay off the debt? – Economists predict that following this course would have catastrophic consequences – If we tried to pay off the debt too quickly, it might even send us into a deep depression – If we keep running large surpluses and pay down the national debt, this will cause a problem for both the Social Security Trust Fund and the Federal Reserve • As the national debt goes down, eventually there would be no securities for them to buy • Still, it is a whole lot better to have problems like these than those caused by running huge budget deficits every year Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 1252 ... $1 trillion 2 Equilibrium GDP Full-employment GDP GDP (in trillions of dollars) Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 12 9 The Deflationary Gap & the Inflationary Gap... 500 500 1,000 1,500 Full-employment GDP 2,000 Equilibrium GDP GDP (in trillions of dollars) Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 12 10 Summary • Equilibrium GDP is above the full... and/or cut taxes Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 12 12 The Multiplier and Its Applications • Any change in spending (C, I, or G) will set off a chain reaction, leading to a