How big is the federai budget T1-h1-iT,ff[JTf$-.docx

How big is the federai
budget' T1-*h:1:-i:::"T,ff["J"'Tf$::-*j]i::#
;;;;;;;;.ess such a tangled
web? ln *nul,
a sruggish economy
like an empty res-
odds with discreilonary
fr.ttilpi]:ty? How ]
fffitl *r,}-l'"t ttt" federai bud-
;";'il" in ientit most Years' and
i^,#il" ,''"P1"' brieflY ii:'"I'-"]:
)"'",-in" ""a
ot trre r99os? *l?: l:
,n?::::;H;i*:,i1":":ff :t;;?ffi 1H:'J"'"'#,'JT""#-T',I':;:;:,,.
whom? Answers to th
questions ."1". ""ili:::"
tl.:Tl
:,:::,',lisnqree E 4 5 s
:;;l'"T'#L
-;;;';"':-
j:::'" Srrci''i'v l':s.qreu s u ,
u
., ,

ffi"ting in theory and Practtce
The word budget derives
from
,h" ;i; ti*.rr -"ta bougette'which w about g4,ooo,ooo,ooo,ooo'oo-
$4
trillion
means
,,litrle bag"
'"i?'"u"'11;:gq::l:::il",ffi:it,:rT '",
iiffru; mo'" ti'11
a vear. rhat,s big monevl
If this "little o"U :;:Xl,'#;t;;;"y stretchingfrom
north-
iJffi ffi i';*:*il* j*jl+;1,:"'*::;,t1il11'"*YJf il jil'.i#F;:*
ern Maine to southern"THJ"; i;;;h;t way to e'"tp ,h.t.ti1T:]0",
rates of geoo perH;;t*";ts for the Year' Here's "l?thit:
:#,'":H"T#J**":r'"i1#tiiti"*t',*;*:xT#Jni'#t?:'";-""'"-' ;;;;'";ent
budgets have.a tremeno'
H3i11#"?:"i",","iiliil",:":"';'rurpi'-s
crsctissecl in
our focus in rhis .i,lft",
w*i.be ci.rpi"; i3 inclucll.' .,,,,.. , . r, . .
the federat budget,' beginning .,.-. ' 1Cn*gOinq{o"iailry*l in
with the budg", pro.L,''fi':

tl"-; e .theiiilderaibudqet Froqes$ '
.",Tll3;;;i;ffiit
'
look ar the source of
federai defi- e,gaticnaietordefnitspe*{ing, siTht€hql*ed:q11-:ff
'
;;r-;;;*theybrieflybecame
e rru': :'' .'
i,,*;toffioi4i.e-tedtid,4.e,!l
crrrnluses. W" ufao ""u'*ine
the g fmpiitoflederal'defiCits ':
:(
: i;r : :
'
',,:?ii::;Hi
""J 'i'''*pact
on
the economY'
Lff1 Th* ff*dermi ffiuaeKg*$-
Fs*e*xs
Thefederalbudgetisaplanofoutlaysandrevenuesforaspecifiedperio
d'
usualiy a year' '"0"'"i

JJo" include uolt' gou""'ment
pxrchases and transter
Davments Exhibit ' ';fi$];]ilJ"'a fiyi
if *"i"':"*?:? since re6o' As vou
Iui., ,"", the share "t';;;;u';"i"c
t" 1i:",:1ei$:i"n3::?ff1 :-i:;?l,i:*ffi',"'
ilil;;;lf in re6o to only
22 perce'ntli
;";;;t care for the *in*unt outravs ano.-
,r,",. r.,u, s,9*' :':;r. ff',X1? $"fi.TJ?,::=;;;" ;i;.: ll_ll; ;.-
1ffiti;:n'ff:il-'
elderly, was introdu:"o
tt,:':tr,:'^:';-*"*-,
aimed primartLy
pe;ruu' r!rr""'
;;i:social securitv ?id Y:1:'-1:?,t:??#;i;;;;"y, i,, 'ooe -F**"*'in
fact, Social Secuflty arru
rvrsu*u^ -' r = leral outiays Tr 2oo9'
l-. .l-'=ta.*'.* combined
for 34 percent of
te(
CIIAFT'gI{ r3 i:i'1eral ll''rliliris
llrC pt'6i'; p'riicl 183

o
F
=
o
0)
:o
0)
o
0.)
o)
(o
a)o
L
c)
o-
i:xlrii:il :.
Defense's Share of Federal 0utlays Declined Since 1960 and
Redistribution lncreased
100%
80%
60%
40%
20%
rgiil ''Jtf/ '5ltf '9t'? f$,?tf fJaRt fS9/ t9i9 t$t? t$flf Atdo A9rl
AtU}9

SoURCES: Computed based an budget totals from fconornlc
Bepoft af the President February 2009, Table B-80; and the
Office of Manage-
ment and Budget. For the latest data, go to Percentage shares
for 2009 are estimates.
For the last two decades, welfare spending, which
consists of cash and in-kind transfer payments, has
remained relatively stable and in zoog accounted
for r4 percent of federal outlays. And, thanks to low
interest rates, interest payments on the national
debt were 7 percent of federal outiays in zoo9, down
from 15 percent as recently as 1996. So 48 percent, or
nearly half the federai budget tn zoo9, redistributed
income (Social Security, Medicare, and welfare); zz
percent went toward defense; Z percent serviced the
national debt; and the remaining 23 percent paid for
everything else in the federal budget-from environ-
mental protection to federal prisons to federal aid to
education. The federa] government has shifted the
focus from nationai defense to redistribution.
The Fresidentia| and
Congressl<>nal RoEes
The president's budget proposai begins to take shape
a year before it is submitted to Congress, with each
agency preparing a budget request. In late January
or early February the president submits to Congress
budget resolution
a congressicnal agree-
men! ab*ut tatal out"
Iays. spendi,]g by mefor
cetegory" and expeeted
revenues: it guides
spending and revenue

decisions by the many
congressional commit-
tees and subcon:nrittees
The Budget of the United States
Government, a big pile of books
detailing spending and reve-
nue proposals for the upcom-
ing fiscal year, which begins
October r. At this stage, the
president's budget is little
more than detailed sugges-
tions for congressional consid-
eration. About the same time,
the president's Council
of Economic Advisors
sends Congress the
Economic Report of the
President, which offers
the president's take on
the economy.
Budget commit-
tees in both the House
and the Senate rework
the president's budget
until they agree on
total outlays, spend-
ing by major category
and expected reve-
nues. This agreement,
called a budget resolu-
tion, guides spending
and revenue decisions
made by the many

congressional com-
mittees and subcom-
mittees. The budget cycie is supposed to end before
October r, the start ofthe new fiscal year. Before that
date, Congress should have approved detailed plans
for outlays along with revenue projections. Thus, the
federal budget has a congressional gestation period
of about nine months-though, as noted, the presi-
dent's budget usually begins taking shape a year
before it's submitted to Congress.
The size and composition of the budget and the
difference between outlays and revenues measure
the budget's fisca1 impact on the economy. When
outlays exceed revenues, the budget is in de-fcit. A deficit
stimulates aggregate demand in the short run but reduces
national saving, which in the long run could impede eco'
nomic growth. Alternatively, when revenues exceed. out-
lays, the federal budget is in surplus. A surplus dampens
aggregate demand in the short run but boosts domestic
saving, which in the long run could promate economic
growth.
Frsblems larith the Federel
Budget Froeess
The federal budget process sounds good on paper,
but it does not work that well in practice. There are
several problems.
Continu ing Resolutions
lnstead of Budget Decisions
Congress often ignores the timetable for develop-
ing and approving a budget. Because deadiines are
frequently missed, budgets lgpically run from year

0%
144 PART 3 Fiscaj ariii ivioretary Policy
to year based on continuing
resolutions, which are
agreements to aliow agen-
cies, in the absence of an
* :l1% overlyDetaired
, ' t l l.( )ri rrl.i: .?.'.l9g"gtLr:r, - ''rrtll-l 1 r---i-^r j.
approved budget, to sPend at
the rate of the Previous Year's
budget. PoorlY conceived Pro-
grams continue through sheer
The federal budget is
divided into thousands of
accounts and subaccounts'
which is whY it fills voiumes'
To the extent that the budget
is a waY of making Political
payoffs, such micromanage-
ment ailows elected officials
to reward friends and Punish
enemies with great Preclslon'
expand. On occasion, the President
must temporarilY shut down some
agencies because not even the continu-

irig resoiution can be approved on time-'
Foi example, in late 1995 and early i996'
most federal offices closed for z7 days'
!g.l.qtf v. Ps9 gsl
P,'gq9?P
You can imagine the difficuity of using
the budget "i "
tool of discretionarY fis
.
ry.e. I e"p"e lPJe. kPi:31 .?=q f,
gst
inertia; successful programs cannot
o
F
I
L
L
I
For examPle, a recent bud-
get included $176,ooo for the Reindeer
ierders Association in Alaska, $4oo'ooo
for the Southside Sportsman Club in
New York, and $S million for an insect-

rearing facility in Mississippi' By bud-
geting in such detail, Congress *1I Jot"
cal poliJy when the budget process takes.
t" fi"g. Ci r"n that the """t"gu
recession lasts only
io *oirftt and that budget preparations begin more
iir""
"
y"tt and a haifbefore the budget takes effect'
pl"""i"g discretionary fiscal measures to reduce
".ono*i.
fluctuations is difficult' That's one reason
*fly u,r"*pts to stimulate an ailing economy often
,""'* ,o haUhearted; by the time Congress and the
president agree on a fistai remedy, the economy
has
often recovered on its own'
"V"l e.g.!Irg I le F !e.
H s 9.g.el.
r"en :.
"
. .

Congress has oniy limlted control over much of
the
U"Ji*. Abovt tht;e-fourths of federal budget outlays are
deteiminedbyexisting lau;s' For example' once
Congress
establishes eiigibility criteria, etrtitiement prc
gre'ms'
such as Social iecurity, Medicare, and Medicaid'
take
onlivesoftheirown,witheachannualappropriation
ri*pfy reflecting the amount required to support the
"rpeciua
number of entitled beneficiaries' Congress
tru, tto say in such appropriations unless it chooses
to change benefits o;;ligibility criteria' Most entitle-
ment piograms have such politically powerful con-
stituencies that Congress is reluctant to mess with
the structure.
sight of the 6ig pi-.t.,t"' When economic
conditions
.n'""g"
"t
*h"ilift" demand for certain public goods
shifts] the federal government cannot easily

real-
io."," funds. oetaiied budgeting is not only time
consuming, it reduces the flexibility of discretionary
fisca1 poliry and is subject to political abuse'
FossEb&e Eudget Refsrms
Some reforms might improve the budget
process' First'
ii."
""""rr
budgel could become a two-yearbudget'
or
ii^":"tbudget.is it is, Congress spends near$ all
of
;;; ;;;.;";king on the budget' rhe executive
branch
;;#"yt dealiniwith three budgets: ad-rninistering an
;;;;"h ilJg"l, a"ru"aing a proposed budgetbefore
congessior.al committees, and preparing
the next
budlet for submission to Congress' With-.a
two-year
budget, Congress would not bL continually
involved

;j,liildg", l"tiu"t",io"s, and cabinet members could
focus more on runnlng their agencies (many
states
have adoptea two-yeaibudgets)' A two-year
budget'
Congress approves a single budget that mixes
capital
"tpJnaitrrr"i,
tii." new iederal buildings or aircraft
."iti"tt, with operating expenditures' like employee
payroils or military meals' Budgets for businesses
"r.t
fot state and local governments usually distin-
gulst] uet*een a capital budgeland an operatingbudget'
ihe federal government, by mixing the two' offers a
fuzzier picture of what's going on'
however, would require lon-
ger-term economic forecasts
and would be less usefui than
a one-Year budget as a tool of
discretionary fi scal Poliry'
Another Possible reform

would be to simPlifY the
budget document bY con-
centrating onlY on major
groupings and eliminating
line items. Each agencY head
would receive a total budget,
along with the discretion
to allocate that budget in a
coniinuing
resolutrons
h*dget agree$le*ts that
allow ageneies" in tlr*
a!:sence o{ ** eg:Proved
bilclget, tc cpend at
ih€ i6t€ *f the Previous
Vear's budaet
entitiernent
programs
suaraEteed benetits tor
i'',*se who qrialilY for
fioverntnant iransier
irogru*u sq'lclr as social
5*euritY *nri fdedirare
CHAPTER r3 F'.:itr:ra; i3r:rcrets and Publtc iJclir;1' 185
stimulqte business investment, consumption, and employ-
ment, was perhaps the shining example of fiscal policy dur-
ing the r96os. The tax cut seemed to work wonders,

increasing disposable income and consumption. The
unemployment rate dropped under 5 percent for the
first time in seven years, the inflation rate dipped
under 2 percent, and the federal budget deficit in
r964 equaled only o.9 percent of GDp (compared with
an average of 2.6 percent since i98o).
Discretionary fscal poliry is a demand-manq.gement
policy; the objective is to increase or decrease aggregate
demand to smooth economic fluctuations. Demand-
management policies were applied during much
of the r96os. But the r97os brought a different
probiem-stagflation, the doubie troubie of higher
inflation and higher unemployment resulting from
a decrease in aggregate supply. The aggregate sup-
p1y curve shifted left because of crop failures around
the world, sharply higher OpEC-driven oil prices, and
other adverse supply shocks. Demand-management
policies are ill suited to cure stagflation because an
increase of aggregate demand would increase infla-
tion, whereas a decrease of aggregate demand would
increase unemployment.
Other concerns also caused poliry makers and
economists to question the
effectiveness of discretionarv / I
fiscai poiiry, These concern's
*€
included the difficulty of esti-
mating the natural rate of
unempioyment, the time lags
involved in implementing
fiscal poliry, the distinction
between current income and
permanent income, and the

possible feedback effects of
fiscal policy on aggregate sup-
ply. We consider each in turn.
lixhibit 5
When Discretionary Fiscal Policy 0vershoots Potential 0utput
14.O 14.2 Real GDP
(trillions of dollars)
to AD'. In the short run, this stimulation of aggregate
demand expands output to $r4.2 trillion and reduces
unemployment to 4.o percent, so the poiiry appears
successful. But stimulating aggregate demand opens
up an expansionary gap, which in the long run results
in a leftward shift of the short-run aggregate supply
curve. This reduction in aggregate supply pushes up
140
o
o
o
'3 130
Discretionary fi scal policy
is a demand-management
policy; the objective is
to increase or decrease
aggregate demand
to smooth economic
fluctuations.

prices and reduces real GDP
to $r+.o trillion, the economy's
potential. Thus, poliry mak-
ers initially believe their plan
worked, but pushing produc-
tion beyond the economy's
potential leads only to infla-
tion in the long run.
Fiscal Policy
.qL9..ig.tilis.q. ". " "..
gg Given the effects of fiscal poi-
iry, particularly in the short
run, we should not be sur-
FHssafi F*63ep amc* €hs
ffi mtucwm $ ffimte #S q$*,n#mpFcxynerecru€
As we have seen, the unemployment that occurs when
the economy is producing its potential GDp is called
the naturs.l rate of unemployment. Before adopting discre_
tionary poiicies, public officials must coffectly estimate
this naturai rate. Suppose the economy is producing its
potential output of $r4.o triltion, as in Exhibit 5, where
the natural rate of unemployment is 5.o percent. Aiso
suppose that public officials mistakenly believe the
naturai rate to be 4.o percent, and they attempt to
reduce unemployment and increase real GDp through
discretionary fiscal poliry. As a result of their poliry, the
aggegate demand curve shifts to the right, from AD
prised that elected officials might try to use it to get
reelected. The link between economic performance
and reelection success has a long history. Ray Fair

of Yale University examined presidential elections
dating back to r9r6 and found, not surprisingly that
the state of the economy during the election year
affected the outcome. r Specifically, Fair found that
a declining unemployment rate and strong growth
rate in GDP per capita increased election prospects
for the incumbent party. Clearly, a weak economy
in zoo8 helped Barack Obama defeat the incumbent
party candidate, Iohn McCain.
'1. Ray Fair Predicting Presidentlal Elections and 1ther Tltings
(stanford,
Calif.; Stanford University Press, 2002).
g
Potential output
CHAPTER rp, i:iscalPaiic't 777
t:
;1"
:r.
.r1i
i'l
;::
i'
{.
:

i:.,
ri
:l'
l.
i,,
t.
l
t:l
*.
.5,r i
Fii
1i
ii
grl
*i
$i
#
fui
Ri
Fj
6rt
a:
$:.
tr:'
h.:
trt

W
?.':
f:l
&i
gsj
ffi:
H
a
F,":,
i.
I
Another Yale economist,William Nordhaus, devel-
oped a theory of poiiiical bnciness eycles, arguing
that incumbent presidents, during an election year,
use expansionary policies to stimulate the economy,
often only temporarily. For example, evidence sug-
gests that President Nixon used expansionary policies
to increase his chances for reelection in 1972, even
pressuring the Federal Reserve chairman to pursue
an expansionary monetary policy.
The evidence to support the theory of political
business cycles is not entirely convincing. Read more
details about fiscal policy and elections in this chap-
ter's case study on 4ltrpress.cengage.com,/econ.
fl-ags Ern FEseeE

The time required to approve and implement fiscal
legislation may hamper its effectiveness and weaken
discretionary fiscal poiiry as a tool of macroeconomic
stabiiization. Even if a fiscal prescription is appropri-
ate for the economy at the time it is proposed, the
months and sometimes years required to approve and
implement legislation means the medicine couid do
more harm than good. The policy might kick in oniy
after the economy has already turned itself around.
Because a recession is not usuaily identified until at
least six months after it begins,
and because the ro recessions
between 1945 and zoor lasted
only ro months on average,
discretionary fisca1 policY allows
little room for error (more later about
timing problems).
DiscretisffiaE"Se
FiseaB Fof;Eey end
Permam*ffi€ $ffi€effi?€
It was once believed that
discretionary fi scal pol-
icy couid be turned on
and off like a water
faucet, stimulating
or dampening the
economy at the
right time by just
the right amount.

Given the marginal
r.r ProPenslty to con-
1r i ,:r, sume, tax changesrl'. r could increase
,:t or decrease dis-
posable income
to bring about
desired change in consumption' A more recent viev
suggests that people base their consumption deci
sions not mereiy on changes in their current incom'
but on changes in their permanent income.
P€rmanent incame is the income a persol
expects to receive on average over the long terrn
Changing tax rates does not affect consumptior
much if people view the changes as only temporarJ
In t967, for exampie, the escalating war in Vietnan
increased military spending, pushing real GDI
beyond its potential. The combination of a boom'
ing domestic economy and higher defense spending
opened up an expansionary gap by 1968. That year
Congress approved a temporary tax hike. The higher
tax rates were scheduied to last only 18 months
Higher taxes were supposed to soak up some dispos-
able income to reiieve inflationary pressure in the
economy. But the reduction in aggregate demand
turned out to be disappointingly smail, and inflation
was hardly affected. The temporary nature of the tax
increase meant that consumers faced only a smal)
cu r'Iir fieti *pretrrtatrYtn*rirtccnta Dkta'uss'Ite?rna1le{n*
income changed little, consumption changed little.
Consumers simply saved less. As another exampie,

in late t9g7,)apanese officials introduced an income
tax cut intended to stimulate Japan's flat economy.
People expected the cut would be repealed after
a year, so economists were skeptical that the plan
would work, and it didn't. Likewise, the stimulative
effects of the $6oo per family tax rebates in zoo8
were disappointing. In short, tothe extentthatconsum'
ers base spending decisions on their permanent income,
attempts to flne-tune the economy with temporary tax
changes are less efJective.
The Feedbask Hffeets cf Fiseal
Fofiiey #m Aggresate SUPPIY
So far we have limited the discussion of fiscal policy
to its effect on aggregate demand. Fiscal poiiry may
aiso affect aggegate supply, although this is usually
unintentionai. For exampie, suppose the government
increases unemployment benefits, paid with higher
taxes on earnings. If the marginal propensiry to con-
sume is the same for both groups, the increased
spending by beneficiaries just offsets the reduced
spending by workers. There would be no change in
aggregate demand and thus no change in equilib-
rium real GDP, simply a redistribution of disposabie
income from the employed to the unemployed.
But could the program affect labor supply? Higher
unempioyment benefits reduce the opportunity cost
of not working, so some job seekers may decide to
search at a more leisurely pace. Meanwhiie, higher
tax rates reduce the opportunity cost of leisure, so
PofrF*y
i'
f

*
I
i
*
nolitical business
ec$nomie fluet$a-
tioils ihat eccur rf'rhen
diselcti€fi ary policy is
n:*nipr:lated f*r politirai
gain
permanent income
i:tecme that individuais
expeet to re**is* sn
gverage cvsr the lili:E
term
17A PART 3 i:isrirl ;inc li'l*::r:taiv Polc-i
6LL .ir',i i'
j d; Hl.Ld-Vll:j
7 :ol o0
'oooz lo lrv lr'n*rsa^urau puP fus^oosu ueJUeuv aql lo
]du3sueli llnl
e l0l
A0olouqral
pus 'aln]3nllsellul '0ul3u0l AlunroS laplo8-uollllur 00 t$

uorlenlP^l pue isal
'lueudolanag'q3le3sau :asua+a0 j0 ]uaul]leda0-uolllll! 00t$
ijlel00.ld xog rafaû0l 0oleuv-ot-letl0!0 aq]-uollllu 099$
VSVN-UOIIIIq t$
p30elue^Pesl0
oql iOl u0lle3npl :uolle3npl j0 luotuuPda0-u0llllq t t$
A0teu3 alqentreuag
pue Acuercrg3 A0laul :A0lau1 1o luau'Lpedag-uollllq B I t$
]uaullssûl sJnlsnjlsellul
Aernq0rg :uollellstutulpV Aenrrq0rg lelspsl-uollllq I lZ$
]JV s!t.11 j0 yed se pe1ero11e alom spuni lelapal Lllrqm
01 sesle
aql j0 Mal s ale alaH ioO Aeuoul leq] lle saop alaL1m 0S
'Auouora
0ur100n4s sql elelnur!]s dlaq pue sqof alealc 0t pauOlsap u0li
-e1sr0a1 1o acard uorllrq /81$ e'6002 +0 ]cV ]uslxlsaûlau
pue
fuanooag u?cuauiv aql passed ssal0uo3
'6002 'tt fueruqa3 ug
Eurpuadg
}USruLIj3&0*

uro4 ma.r8 snifuns FlapeJ aL{I'uonlq o6z$1o aurq
aq}
]e proJar e paqJeal ralllea sread xts dluo leqr lTJgap
aql ul 'slaildrllnru 8urxel pue Surpuads aI{} Jo azls aq}
af,npal leql srolJeJ lelaâs paululExa osIE 1l'artlle;d
ui pue d;oaql ui dlliod lef,sg passnf,srp -raldeql stql
ff;*s"v gffiaxls
'raldeqr lxau arp uI Passnf,slP ele
lqap letapa; SuPpsa-r aql pue slIJUep lelapal Jo
suoa
-e;qdul;aqunJ 'uolllul z$ pue uouFl r$ uaaalaq ]se)
-aroJ uaaq aêq sltrqap 'Surpuads snlnu;qs pasearf,ul
pue '.slnolieq 'sanuaaa.t xel laôl qlw'8ooz uI uoil
-pq oSn$ ot pasear)ui llrgap la8pnq IErapeJ aql'sure8
lu"rn
"-.oqipasrenal
looz ;aqu;arag ur dleng;o ue8eq
]eqt uorssa3a-: aq1'looz ur uoqpq t9r$ o1 tooz
uI uo{Iq
oot$ lnoqe u:o4 lilgap Flapa] ar{l lnr padlaq diuouon
Surriaq€ua:rs aq;.'sqof uoITIIur 8 ueq] aroru pappe du:o

-uof,e eqt 'loaz pue Eooz uaatnlaq'lng
'tooz SoJleq puo
-"",
"q1
1nt. ure8e Suvno-r8 uels lou plp sqof
pue '4ea*l
sern rfia.torar aq] 'srououl rqSra dluo palsEl uolss3f,al
aq1 q8noqtly'r{-ralorar JIu-IouoJa Suor}s e Jo saJuer{f,
aq] paJnpa, pue sa^rl Jo spuesnolp pepua saueid-rre
paarefiq JnoJ uI uaur uaolaulu 'rooz 'rr raquraldas
;" ;"qi.,'ltt"8" Suraour durouora aql ta3,, o1 lnf, xel
-rear{-oi 'nonfo S€'r$ preoq-aql-ssorJe ue q8norql
paqsnd qsna 'tvf a8-ioa3 luaplsard pallola dirnau os
iroirr"r", € paJal]ns du;ouola eql'rooz dpea ur lng
'oooz ur uogiq 9tz$ ol 966: ur uo111tq ol$
e ']r)gap lerapal aI{] }no pa{Jou{ qlund offtl-auo }Bq}
'g66r-{g 'rea{ rad luaorad z't f,1uo Sura'ro'r8
(>iJaq) uI
peuieural sdepno ierapaJ'ailr{^ue3{rl 1966r pue t66r
uaa/yqaq;ear{ -rad luarrad E'3;o a8elane ue Surmo€
'uo13urqse7y1 olur paqsnS sanua^ar xe1'la3pnq ielapa]
aqt Jo f,Iueudp aqr pa8ueqr-{ruouole Suruaqt8uarls
e pue 'aurldrtsrp Surpuads arour 'I{Du aq} uo saxel

-raq8iq-sluala esaql Jo af,uanguor aI{J 'd-rolstq ut
la)i;euJ 4co1s lsa8uo-t1s eql pue 'uo1en1eqo18la>Fetu
'uoqerrouul leriSoiouqrat uo paseq tusturndo ssaulsnq
Sursu pue Surpuads ratunsuof, Suino'l€ dq paianl fua
-AoJer 3uor1s e peruauadxa dtuouora eql 'a1q/tueel
'ra8pnq ai{l aJueleq o1 ueld s1r 3o ued se Surpuads
IErapaJ uo auridrlsrp alour pasodui l65t ur pellala
ssa;3uo) uellqndag aq1'(paira11of, sex€1 eulof,ul lela
-pa; Jo splTq]-ornl lnoqe ded sJaulea Jo lual-rad
or dol
aql) saxel auro;ul lelapa;Jo aleqs s,uorl aqt sded leql
dno.r8 e 'spioqasnoq au-iolur-q8iq uo saxel aseaJJui
dlieeuelsqns ol a8eueu plp aq 't66r ur 1nq'a8e4red
snlnruqs sq qlur {e.'n stq }aB }ou pip uolull)
]l;gap Suruapirrr e Jo saf,Jnos Suqsnq-la8pnq
se uoqrsoddo eql dq pazlf,llltf, dlapyn ale^ ur-Ial lsrg
srq 8ulrnp stnJ xul s,qsng luaplseld
'lilgap la8pnq aqr
asea-tf,ur plno,rl ll leql Suin8re 'arnseaur aq] pa>polq
,l r"rroddo- 1111 'r{em lopun fpearp se/t 1eql fuanolar
aqr dlaq ot t66r dpea ur a8e4ced snlnuFs lsaporu e
pasoao-ta uolull) luaplsa-Id'eldurexa 'ro1 dtuouola aq1

"1"1n*t1t
ot sllrgep Sursea-rlut dyrsnf o] pleq se'& ]1
'suorsuedxa f,Iuiouof,a Suunp q8rq {pearle ala'ff sIIJI
-Jap asnef,ag'uoqezllrqels JlurouoJe lo; iool e se 6{od
fersg rfieuoqarrslp Jo asn eq]
paJnper so66r aqrloSieq
itr,l p,r* sog6r eqt Jo slllgap le8pnq lerapal a3're1 aq1
5An3!*a* s& ry3e& $esnldims
s& s&!}!#sffi e&[email protected]"ds :0661 asuEs
'196r ur pano;dde strnJ xe] arF pale^Iloul let{l
roqeiJo dlddns oqt uo saxelJo s])eJ;a aql ]noqe ula)
-uof, se.{r 11 'sanqod lelsg a}enlela a4 uaqld pulur
ur slf,a;Ja {:epuores asaql deal Plnoqs a7v1'saruanb
-uruor--pupuulurun dllunsn an slta$a asaq] q6not4llD
'lsanut puD 'anls 'puads '4tom ol sanllualuJ 1unplnryut
pa[{o [ow'sa7l) xD1 u1 saiuo6t sD l'{]ns 'satrllod lots{ fuCI
-uoilutttlp pul'xvl au;'o)ut aassat6otd a] puo a)uotnsut
lua,af,oldu,nun sD i{Jns 'snztltqols Jl}Dlilo}no
1'I7og
a6t 1ellualod s,druo
-uoJa aql Surlnpar'r{1ddns ate8a-i83e asealf,ap
pinor!
roqei Jo f1ddns ai{} ul asea]f,ap

y-'s8ururee uo saxel
r"qgiq dq papunl slgauaq luaur'{o1du:aun 'raq8rq 3o
tlnsar e s€ asearf,ap plnol loqel 1o dlddns arp 'uoqs
ul 'srnoq ;e^lal {ro1t 01 epllep ''{eur sqof q}un aluos
a federal deficit' Note that
a contractionary fscalpolicy
nirrs to close an exPansionary
gaP'
The $hEuBtiBlBeE and
the Tfrme F{orfizsm
in the long run $ zero'
classical
econorrtiSts
a grsrrp ef 18th- an"-i
'!Sti?-s*iltilrY ecs$$-
n-?:5t3 wh* believeC fhat
ee;:n*nriu d*wntursrs
t.jtl*ctct! th e?lt5s lves
thr*uqh natulal n'!arker
farces; thus.:it*Y
ileliev€d the eccn0lnV
was self-enrrecting anct

*eer!*ei no g*seri!rfi **1
!nterv*nt!at't
The proper execution of cl -.-nr1r
;;;J";6nary and contractlonal) ,
h?5;i;;1i;i;" assurnes that: .. , i=
11
e potenrial0utputisaccuratelygaugeq: ' ' , i*
8 the retevant spending.multiplier can be pred|cled
accuratery ; 2
I ' . aggregate demand can ne ifiitteO bt iusi
the right ayount -
t ?
' : 'r r : ' I.'
cansomehilw coordinate
their i -Ho valisui glvemrnenLe*t!
'
e)
':liseal.ei{otts-: '' : ,, i
o the shape 0f the short-run agsregate t',Plll::ft
is known
:- ;;l;#.i-t unaffected bv the fiscal policv itsen'
lBtAt-1iii;;',iFuiGiL*H-i;
, T"lf-:.f*l

t
I
:1."i1
n
.h l'' ':,.:;'Tl:"-'.::4
.in" ),ti-Jt1-' "
{
3
e"t;"?
'E-t *.l
.'i
;:t't
,tr
ffi
hi..I
:t*i
E
H
'r r'
"61;.,
;-',-.f,.?' '
,... .i::r;'
#@

':iia
',:t'"
i
i
!
t
?ti
i:
t
L03 Th* Evmiuti*r:
*f Fi*e s3 F*3ieY
bJow that yau have sorrle
idea of how fiscal po1*
icv can u'ork in th";t' let's take. a
iaok at fiscal
IJtn" 1"' Jrr*,i.*, uugitt"i"g wich
the approach
Lsed-before the Great Depresston'
Pr'aor ts the Gneat SePressFern
Before the r93os, discretionary
fisca1 policy was se1-
dom used to l'-'n'-t""t" th" 'n"t'o"conomy'
Pubiic
;it.t-;; ,l'up"a uf-tr'" views.of 'l'"tti:*

econo"
mists, who advoca'li'1o"tn'-Joire'
the beiief that
;;;"t*";s were the best way to l+i"*
economlc
orosperity. ciassicat
"eco''o*ittt
did not deny that
Ltt:;t;;t; high unemplovment
occurred from
time to time, but tft"V'"tgi"i that
the sources of
such crises t"y ot"'iiu th'" *"'k"t :f5*'
in the
effectsofwars,taxincreases'poorgowingseasons'
changing tastes, "";';l;
like' such external shocks
could reduc" o"tnt'i "^a "*pt"y*"ltl-b,tt
classical
economists u"rl"t'"a tT-'"i tl-uC'"i
*utket forces' such
as changes i'' p'it"'' *lg"t' ""a
interest rates' could

correct these Problems'
'" ""'*oiu oli ::lT :';X ;TJ:TIIJ,f, :$ ;1 ?l i:
the economy's Prrce I(
was produced, prices would
fall until the quantlty
]"*i'ff
"
;;;iil i]:"1r:f '_i:Tli,* i: Y"-;;
H:: JT"lisi"li J#ffi: il;;'; ;t il'-".: suppiied
:"";;;;ilqt'""titv a"*anded' And
if the interest
;1" ;;iigi' t" ii*'i "u
that had been saved'
interest rates would;;ii;;iii the
amount invested
"q"uf"a
the amount saved'
So the classrcai upp'o"ttt
i*plied that natural mar-
ket forces, through fl'exible
prices' wages) and inter-
est rates, would *o"" th" "to"o*y
toward potential
.rn the short run, the aggregate-
supp!

-curve
s10pes ;
upward, so a shift of 'ffigui"
demand crha'rgtes tretJr
the price levei and tt-'"e"1tti"r
of output' wlen aggre-
#"?;''' ;::"11",:i,*,**tf;*X'"'ff11 i
A*Tiru]"JilXl"ir;;;" "i"q"iiiu'ium
o"tpui in i
the short run depenas o'''tf'" stelpness
ofthe aggre- :
gui",.,pprv..,*Iuj .x5*"::'j"ff:ilff"li*X i
;ff:*:;#:ffiffi;;;l"io*'upptv'u"n'
ih' 1"'',
tmpacl a givenshrJt oJ ')''n
ois"S*" d'emand curvehas on i
real GDP andthe ^"'i^i"'li-ti.;*
*the price leuel' so
i'tiu'
,iott , the spending multiplier' -:.,^i-a irc nnrpn- i'"" ;;';; *to*y
ii already producrng
its poten- I
tial, then in the t"r '""'-#:il::"t":::"1'ff:T:tt:: i

:l?$";;T';;;ffic dema"d increases'
the p'ce
i#il#, "ot "nltt
output' Thus' if the economv
is already producingn' fotnntiof'
the spending multiplier
i
i
:
?
i
i
t
!
t
t
:
i
The exact
change of
equilibrium
outPut in the
short run
depends on the
steePness of the
aggregate suPPlY

curve.
174 PART 3 f iricai atlti idorrerarY
PolrrrY
GDP. There appeared to be no need for government
intervention. What's more, the government, like
househoids, was expected to live within its means.
The idea of govemment running a deficit was con-
sidered immoral. Thus, before the onset of the Great
Depression, most economists believed that discre-
tionary fiscal poliry could do more harm than good.
Besides, the federal government itself was a bit player
in the economy. At the onset of the Great Depression,
for exampie, federal outlays were less than 3 percent
of GDP (compared to about z4 percent today).
The Great ffiepressE##r
end ffifon&d War E$
Although classical economists acknowledged that
capitalistic, market-oriented economies could expe-
rience high unemployment from time to time, the
depth and duration of the depression strained belief
in the economy's abiiity to mend itself. The Great
Depression was marked by four consecutive years of
contraction during which unempioyment reached z5
percent. Investment plunged 8o percent. Many facto-
ries sat idle. With vast unemployed resources, output
and income fell well short of the economy's potential.
The stark contrast between the natural market
I adjustments predicted by classical economists and
! the years of high unemployment during the Great

g Depression represented a collision of theory and
$ fact. in 1936, John Maynard Keynes of Cambridge
H University, England, published The General Theory
I of Employment, Interest, and Money, a book that chal-
fr tenged the classical view and touched off what would
fr later be calied the Keynesian revolution. Keynesian
2 theory and palicy were developed in response to the prob-
), Iem of high unemployment during the Great Depression.
.' Keynes's main quarrel with the classical economists
5 was that prices and wages did not seem to be flexible
o enough to ensure the full employment of resources.
d
;t
'l
According to Keynes, prices and wages were rela-
tively inflexible in the downward direction-they
were "sticky"-so natural market forces wouid not
return the economy to full employment in a timely
fashion. Keynes also believed business expectations
might at times become so grim that even very low
interest rates would not spur f,rms to invest all that
consumers might save.
It is said that geologists learn more about the
nature of the Earth's crust from one major upheaval,
such as a huge earthquake or major volcanic erup-
tion, than from a dozen lesser events. Likewise,
economists learned more about the economy from
the Great Depression than from many more-modest
business cycles. Even though this depression began
about eight decades ago, economists continue to sift
through the rubble, looking for clues about how the
economy realiy works.

Three developments in the years following the
Great Depression bolstered the use of discretion-
ary fiscal poliry in the United States. The first was
the influence of Keynes's General Theory, in which
he argued that natural forces would not necessariiy
close a contractionary gap. Keynes thought the econ-
omy could get stuck well below its potential, requir-
ing the government to increase aggregate demand to
boost output and employment. The second develop-
ment was the impact of World War II on output and
employment. The demands of war greatly increased
production and erased cyclical unemployment dur-
ing the war years, pulling the U.S. economy out of
its depression. The third development, Iargeiy a
consequence of the first two, was the passage of
the H;rrplayment A{t of :945, which gave the fed-
erai government responsibility for promoting full
employment and price stabiiity.
Prior to the Great Depression, the dominant fiscal
policy was a balanced budget. Indeed, to head off a
modest deficit in 1932, federal tax rates were raised,
which only deepened the depression. In the wake of
Keynes's General Theory and World War II, however,
policy makers grew more receptive to the idea that
Sscal poliry could improve economic stability. The
objective of fiscal poliry was no longer to baiance the
budget but to promote full employment with price
stability even ifbudget deficits resulted.
Autematse
Stcb$Efreers
This chapter has focused
mostly on discretionary fis-

cal policy-conscious deci-
sions to change taxes and
Employment
Act of rga6
law that assigiled t{] the
federal govr:rn*reni the
responsibility for pro-
rnoting full eFlpl6yr"nent
ancl priee stability
C]{AFTIR r: ii:;cai Pclicir 175
government spending to achieve the economy's
potential output. Now let's get a clearer picture of
automatic stabilizers. Automatic stabilizers smooth
out JTuctuations in disposable income over the business
cycle by stimulating aggregate demand during recessions
and dampening aggregate demand during expansions.
Consider the federal income tax. For simplicity, we
have assumed that net taxes are independent of
income. In reality, the federal income tax system is
progressive, meaning that the fraction of income paid
in taxes increases as a taxpayer's income increases'
During an economic expansion, employment and
incomes rise, moving some taxpayers into higher
tax brackets. As a result, taxes claim a growing frac-
tion of income. This slows the growth in disposabie
income and, hence, slows the growth in consumption.
Therefore, the progressive income tax relieves some
of the inflationary pressure that might otherwise
arise as output increases during an economic expan-
sion. Conversely, when the economy is in recession,
outpur dec.lirre-", e-mploymenf and jncomes fal!. mov-

The Economy
Progressive
lncome Tax
Welfare
Benefits
176 PART 3 Frscel arrd lloneiary Pclrcv
ing some people into lower tax brackets. As a result,
taxes take a smaller bite out of income, so disposable
income does not fall as much as GDP. Thus, the pro-
gressive income tax cushions declines in disposable
income, in consumption, and in aggregate demand.
Another automatic stabilizer is unemployment
insurance. During economic expansions, the system
automatically increases the flow of unemployment
insurance taxes from the income stream into the
unemployment insurance fund, thereby moderating
consumption and aggegate demand. During con-
tractions, unempioyment increases and the system
reverses itself. Unemployment payments automati-
cally flow from the insurance fund to the unem-
ployed, increasing disposable income and propping
up consumption and aggregate demand. Likewise,
welfare payments automatically increase during
hard times as more people become eligible. Because
of these automatic stabilizers, GDP fluctuates less than
it otherwise would, and disposable income varies pro-
portionateiy less than does GDP. Because disposabie
income varies less than GDP does, consumption aiso
fluctuates less than GDP does.

The progressive income tax, unemploymentinsur-
ance, and welfare benefits were initially designed not
so much as automatic stabiiizers but as income redis-
tribution programs. Their roles as automatic stabilizers
were secondary effects of the legislation. Automatic
stabilizers do not eliminate economic fluctuations,
but they do reduce their magnitude. The stronger and
more effective the automatic stabilizers are, the iess
need for discretionary fiscal poliry' Because of the
greater influence of automatic stabilizers, the economy
is more s tabie to d ay lh an it w as dur ing lhe Gr e at D epre s
s ion
andbefore. As a measure of just how successful these
automatic stabilizers have become in cushioning the
impact of recessions, consider this: Between r948 and
zoo8, real GDP deciined during seven years, but real
consumption fell during only two years-by o.8 per-
cent in ry74andby o.3 percent in r98o. Real consump-
tion deciined in only two of the last 6o years. Without
much f anf are, qutomatic stabilizer s hav e b een quietly doing
their work,keeping the economy on a more evenkeeT.
Freirn the €olden
Age to Stagflation
The i96os was the Golden Age of fiscal poliry. )ohn F. .
Ketile{1 Nas $etspresi{eltto praQsse a {ederal t-
budget defrcit to stimulate an economy experlenc- !
ing a contractionary gap. Fiscal policy was also used p
o occasor to pro.rite a extra kick to arr expan- !
sion already under way, a$ in lg6+, when Kennedy's $
successor, iyndon B. /ohnson, cut income tax rates 5
to keep an expansion alive. This tax cut, introduced to e

How big is the federai budget T1-h1-iT,ff[JTf$-.docx

How big is the federai budget T1-h1-iT,ff[JTf$-.docx

Recommended

Recommended

More Related Content

Similar to How big is the federai budget T1-h1-iT,ff[JTf$-.docx

Similar to How big is the federai budget T1-h1-iT,ff[JTf$-.docx (14)

More from adampcarr67227

More from adampcarr67227 (20)

Recently uploaded

Recently uploaded (20)

How big is the federai budget T1-h1-iT,ff[JTf$-.docx