Chapter 4-Budget analysis and deficit financing

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Presented discounted value

the value of each periods dollar amount in todays terms PDV=F1/(1+r) + F2/(1+r)^2 slide 17

largest tax cuts in our nation's history

2001 reduction,

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Dynamic scoring:

: A method used by budget modelers that attempts to model the effect of government policy on both the distribution of total resources and the amount of total resources.

Implicit obligation:

: Financial obligations the government has in the future that are not recognized in the annual budgetary process.

Automatic stabilization:

: Policies that automatically alter taxes or spending in response to economic fluctuations in order to offset changes in household consumption levels.

Real prices

: Prices stated in some constant year's dollars.

Nominal prices

: Prices stated in today's dollars.

Deficit

: The amount by which a government's spending exceeds its revenues in a given year.

Ex post BBR

A law forcing a given government to balance its budget by the end of each fiscal year.

Balanced budget requirement (BBR):

A law forcing a given government to balance its budget each year (spending = revenue).

Ex ante BBR:

A law forcing either the governor to submit a balanced budget or the legislature to pass a balanced budget at the start of each fiscal year, or both.

Cyclically adjusted budget deficit:

A measure of the government's fiscal position if the economy were operating at full potential GDP.

Cash accounting:

A method of measuring the government's fiscal position as the difference between current spending and current revenues.

Capital accounting

A method of measuring the government's fiscal position that accounts for changes in the value of the government's net asset holdings.

Static scoring:

A method used by budget modelers that assumes that government policy changes only the distribution of total resources, not the amount of total resources.

Intertemporal budget constraint:

An equation relating the present discounted value of the government's obligations to the present discounted value of its revenues.

Consumer Price Index (CPI):

An index that captures the change over time in the cost of purchasing a "typical" bundle of goods.

Generational accounting

Assesses the implications of the government's policies for different generations of taxpayers.

Automatic stabilizers:

Automatic reductions in revenues and increases in outlays when the economy shrinks relative to its potential.

Why Care About the Deficit?

Budget deficits can affect the amount of savings and growth in the economy. Today's deficits are tomorrow's taxes, so high deficits imply redistribution from future to current generations.

More capital, more growth

Capital accumulation is a key part of economic growth. A larger capital stock means more total output for any level of labor supply. Thus, growth in the capital stock drives (per capita) growth.

Ricardian equivalence

If the government borrows from future generations to increase benefits to the current generation, people will simply save the extra money, leaving a larger bequest. This implies that government debt has no impact on the economy

Mandatory Spending (or Entitlement spending):

Mandatory funds for programs for which funding levels are automatically set by the number of eligible recipients, not the discretion of Congress.

Discretionary spending:

Optional spending set by appropriation levels each year, at Congress's discretion.

The Balanced Budget and Emergency Control Act (also known as the Gramm-Rudman-Hollings Deficit Reduction Act, or GRH)

Passed in 1985 in an attempt to control the budget. Initiated automatic spending cuts once the budget deficit started missing specified targets. The cuts were avoided by gimmicks, such as changing the targets.

Discretionary stabilization

Policy actions taken by the government in response to particular instances of an underperforming or overperforming economy.

Failure to meet GRH deficit targets led to the 1990 adoption of the Budget Enforcement Act (BEA):

Rather than trying to target a deficit level, the BEA aimed to restrain government growth. It created the pay-as-you-go process (PAYGO), which prohibited any policy from increasing the estimated deficit in the next six-year period. If deficits increase, the President must issue a sequestration requirement, which reduces direct spending by a fixed percentage. successful

Debt:

The amount a government owes to those who have loaned it money.

problem with long-run imbalance

The long-run imbalance measures only consider the pattern over time of transfer programs, and not of other investments and government policies.

Interest rate:

The rate of return in the second period of investments made in the first period. determines amount of capital accumulated The higher is the interest rate, the more people want to save (supply), but the more it costs firms to invest (demand).

Short-run stabilization issues

The role of the government in combating the peaks and troughs of the business cycle.

Theory therefore tells us that higher deficits lead to higher interest rates and less capital investment

Theory therefore tells us that higher deficits lead to higher interest rates and less capital investment

When policy changes, household behavior....

also changes, potentially affecting the budget deficit.

Cash accounting treats a birthday party and an office building as identical, but capital accounting does not.

birthday treat

The key concern about federal deficits

is that the federal government's borrowing might compete with the borrowing of private firms.

Intergenerational equity:

the treatment of future generations relative to current generations. budget deficits mean more benefits for the current generation relative to future generations