Fiscal policy: Deficit and Debt

1. Advantages and Disadvantages of different types of Fiscal Policy

Type of Fiscal Policy	Advantages	Disadvantages
	1. May be growth will continue	1. Budget worsens
	2. May solve short run political problems	2. Hurts country's ability to borrow in the future
Expansionary	3. Decreases Unemployment	3.Trade deficits may increase
		4. upward pressure in interest rate
	1. May help fight inflation	1. Risks recession
	2. May allow better monetary/fiscal mix	2. Increases unemployment
Contractionary Fiscal Policy	3. Trade deficit may decrease	3. Slows growth
		4. May help cause short run political problems

A brief history of post World War II macroeconomic polity

New Deal : "do something " approach of 1940s, boom

War time economy : price control and low unemployment

Decreased government spending let to recession during 1949

In 1950 Kerean War started and increase in spending

The Korean war ended in 1953 led to recession 1953-54

Automatic stabilizers caused expansion by the end of 1954

Increase in reserve requirement and discount rates to controll infation

2. Budget Deficit: a brief history

Deficit = revenue - expenditure:

Before the World War II governments would run surplus at some time and deficit at other times. But since then the :United States has run consistent deficits. The public debt has accumulated substantially.

Why such a change after World War II ? Beacuse regeme has changed; introduction of Keynesian ecconomics and the use of discretionary fiscal policy.

Even aftr the Keynesian regeme was replaced by the New Classical supply-side policy regeme during 1980s the deficit still grew faster. The Gramm-Rudman Act in 1983 (?) mandated elimination of deficit by 1991 but without success. Therefore some argue for balanced budget amendment to the U.S. Constitution.

The most democracies have problem in self controlling.

However, to judge a country's debt you must view its debts in relation to its assets. An example.

if country A has $300 billion debt and $500 assets, and country b has $100 billion debt and $100 assets ; A is still in better position.

Important concepts:

Arbitrariness in defining debt

Internal government debt

External government debt

difference between individual and government debt

Ratio of deficit and debt to GNP

Real deficit = Nominal deficit - (Expected inflation * Debt)

Reasons for debt

Unfunded Social security payments (projection of workers per social security retirees).