Federal Budget Deficit

General Information

Definition: The opposite of a budget surplus, a deficit is when the government spends more money than it takes in. Essentially government expenditures and transfer payments are greater than the revenue from taxes. This is assuming that taxes are the main form of revenue.

G>T = A budget deficit

G= federal, state, and local government spending on currently produced goods and services

T= federal, state and local tax revenue

INCLUDE Graph

Stabilization Policy

-In terms of stabilization policy, the budget has three variables that affect macroeconomic goals:

• Government purchases of goods and services
• Government transfer payments
• Government tax reciepts

-How does the government budget deficit work as an automatic stabilizer for economic activity?

-As GDP increases then taxes increase as well. The revenue from taxes in higher so the deficit is smaller in times economic prosperity. As this happens, fiscal policy becomes more resrictive and this in turn dampens the expansion.

-A shock the causes economic activity to fall means that the deficit will increase because tax revenues are smaller then before. In addition, in times of low economic activity, unemployment is high and so are government transfer payments like unemployment compensation, and thus government expenditures rise. This cushions the fall in national income.

-Are government budget deficits good or bad?

• This can depend on what the excesses expenditures are being used for.
• For example: if the government borrows to deal with a recession, to fund self-defense, or for public investment it is not a bad thing.
• Obviously wasteful expenditures would be bad

-Ways to deal with the federal budget deficits:

• revenue from taxes
• government bonds: leads to open market operations
• money creation: leads to sustained inflation

-In the US, the government is not allowed to issue new currency to pay off bills.

• Must fix deficit with an increase in taxes or by issuing bonds to the public

ADD GRAPH 636 from moneny and banking book

Types of Deficits

-In 1989, President Reagan called for a constitutional amendment that would mandate a balanced federal budget.

-In 1995, congress voted against the amdendment

-Kenynesians are the main opponents of a balanced budget. They argue that deficits stabilize the economy and are actually required.

• The tax transfer system acts as an automatic fiscal stabilizer and a deficit or surplus is neccesary at the appropriate time in the business cycle.

Cyclical Vs. Sctructural Deficits

-Federal budget deficit depends in part on the level of economic activity.

-Cyclical Deficits: are the portion of the federal budget deficit that results from the economy being at a low level of economic activity.

-Structural Deficits: are the portion of the federal budget deficit that would exist even if the economy were at its potential output.

-Keynesians believe that cyclical deficits show that automatic stabilizers are working as desired.

-On the other hand, strucutral deficits are not directly attributable to the behavior of the economy.

• Structural deficits are the direct result of policymakers' decisions. For example: tax rates, level of government spending and benefit levels for transfer programs.

-Keynesians believe that large structural deficits reflect a mistaken mix of fiscal and monetary policies.

• Perhaps these deficts are the result of overly expantionary fiscal policy.

Current State of the Federal Budget Deficit

-The federal deficit fell to a four year low recently. The deficit for the budget year that ended September 30th was 22.3 percent lower than the $318.7 billion imbalance for 2005. The deficit for 2006 was 247.7 billion dollars.

-President Bush attributes the decline to his tax cuts.

-In 2004, Bush pledged that he would cut the budget deficit in half by the year 2009. Now this seems to have been achieved three years ahead of schedule.

-Democrats critical of Bush believe that this decline is only temporary and that the deficit will increase again soon

"Only a president with such a historically bad economic record would be this excited about a $248 billion deficit," said Rep. Carolyn Maloney, D-N.Y. "Under his watch ... record surpluses turned into record deficits as far as the eye can see." (FOXNews)

-In 2006, tax revenues grew by 11.7 percent while government expenditures only grew by 7.3 percent.

-Originally the predict deficits was more then 423 billion.

"Republicans said the big improvement showed that Bush's economic policies were working to stimulate growth and boost tax revenues. But Democrats said the narrowing of the deficit would be temporary as the pending retirement of 78 million baby boomers will send costs of the government's big benefit programs soaring." (Fox)

• Here we can see how the government transfers expenditure aspect of the deficit is believe to increase in the future, causing the deficit to increase.

What can we expect in the Future?

As we have discussed, a Federal budget deficit can have a positive and negative impact on the economy. A deficit can stimulate the economy which results in higher levels of business activity and profitability. Also, a deficit can help to create business and investor optimism because of more employment opportunities. Conversely, a deficit that is too large can lead to a rise in inflation. Deficit spending may also create a rise in unemployment, but lower the inflation rate, however the main objective is to maintain a level of balance.

With a current national debt of roughly $8.5 trillion, many questions and concerns have been raised about the future plans for the Federal Budget. The budget deficit for the 2006 fiscal year was $248 billion, which is down from the $319 billion deficit in 2005. President Bush has implemented numerous pro-growth policies that have generated historic revenue growth, resulting in a deficit reduction. In fact, over the past three years the budget deficit has been more than cut in half.

2007