The Budget Deficit and Stabilization Policy:
A raise in government purchases increases aggregate demand. It shifts the IS curve out as well as to the right increasing the level of real GDP for every possible value of the interest rate. A diminish in government tax collections as well increases aggregate demand as well shifts the IS curve out. The government’s budget deficit is equivalent to purchases minus net taxes. Why bother with two procedures of fiscal policy purchases and taxes when you can just keep track of their difference?
This drive for the generality is the reason for focusing on the government’s budget balance as a measure of fiscal policy. However it turns out that the right measure of budget balance isn’t the government’s actual deficit or surplus. In its place the right measure of fiscal policy is the full-employment or cyclically-adjusted deficit (or surplus) what the government’s budget balance would be if the economy were at full employment.
Regrettably the government budget bottom line reported in the newspapers is either the unified cash balance or the excluding-Social Security balance. The first of these bottom lines is the dissimilarities between the money that the government actually spends in a year and the money that it takes in. This balance is called unified for the reason that it unifies all of the government's accounts and trust funds including Social Security. This balance is called cash for the reason that it doesn’t take account of changes in the value of government owned assets or of the future liabilities owed by the government- it is just cash in minus cash out. The subsequent of these bottom lines is equal to the unified cash balance minus the revenues as well as plus the expenditures of the Social Security program. It obtains the Social Security system off budget.
Why is the full employment budget balance a better index than either of the more habitually mentioned cash balance measures? Consider circumstances in which the government doesn’t change either its purchases or its tax rates and so there is no change in government fiscal policy. However suppose that monetary policy tightens- real interest rates are raised and so the economy moves up and to the left along a stable IS curve. As the economy moves besides the IS curve real GDP falls and tax collections fall too. The government's cash deficit rises, although there has been no change in government policy to shift the IS curve. The full employment budget balance but remains constant. The reality that the cash budget balance changes as the economy moves along a constant IS curve means that it isn’t a good indicator of how the government's fiscal policy is affecting the location of the IS curve- the full employment budget balance is better.
To turn the cash balance into the full employment balance we should adjust the budget deficit or surplus for the automatic reaction of taxes as well as spending to the business cycle. When unemployment is high taxes are low as well as social welfare spending high. The budget balance hangs toward deficit. When unemployment is low taxes are high as well as the budget balance swings toward surplus.
Additionally to cyclical adjustment there are three other adjustments to the reported budget balance that we would consider making.
One adjustment economists make is to right the officially-reported cash budget balance for the effects of inflation. A portion of the debt interest paid out through the government to its bondholders simply compensates them for inflation’s erosion of the value of their principal.
Yet another modification corrects for an asymmetry between the treatment of private and public assets. Private expenditure on long-lived capital goods is called investment. A business that has costs of goods sold of $90 million, total sales of $100 million and spends $20 million on enlarging its capital stock reports a profit of $10 million - not a deficit of $10 million. Standard as well as sensible accounting treatment of long-lived valuable assets in the private sector is definitely not to count their entire cost as a charge at the time of initial purpose however instead to spread the cost out--a process called amortization over the useful life of the asset. The government must do its accounting the same way like a business as well as amortize rather than expense its spending on long lived assets.
All of the issues surrounding capital budgeting come out again whenever the long-run future of the government’s budget is considered. Back when I worked at the Treasury Department a few $10000 a year was set aside for me in my Treasury pension account. It is as if my earnings had been $10000 a year higher and I had invested that extra $10000 in U.S. government bonds. Bonds issued by the government come out on the books as part of the government’s debt. However pension fund liabilities that the government owes to ex-workers don’t.
Therefore there is a sense in which the right way to count the government’s debt is to look not just at the bonds that it has issued but at all of the promises to pay money out in the future that it has made. Certainly a large chunk of the government’s expenditures those by the Medicare as well as Social Security Trust Funds for instance - are presented to the public in just this way. The Social Security deficit tale by the Trustees of the Social Security System every spring isn’t the difference between social security taxes paid in and social security benefits paid out however is instead the long-run seventy-five-year balance between the estimated value of the commitments to pay benefits that the Social Security System has made as well as will make as well as the estimated value of the taxes that will be paid into the Social Security Trust Fund.
However the Social Security Trustees Report covers just one program albeit a big program. And great mystification is created by the fact that the Social Security systems expenditures and revenues are also included within the unified budget balance. Wouldn’t it be better to bring all of taxation as well as spending within a long-run system like that currently used by Social Security?
Economists like Laurence Kotlikoff as well as Alan Auerbach say yes! They propose in its place of the year-by-year budget balances that the United States government shift to a system of generational accounting. Generational accounting would study the lifetime impact of taxes and spending programs on individuals born in specific years and that would come up with a final balance that could be used for long-term planning. It is hard to run off the conclusion that Auerbach as well as Kotlikoff has a very strong case. Yet only some analysts of the budget use their generational accounting measures. Generational accounting is therefore not part of the present state of macroeconomics however I hope that it is part of its future.
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