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>> Fiscal Policy Section 4: Long-Run Implications of Fiscal Policy chapter 12 The Japanese government built the bridge to Awaji Island as part of a fiscal policy aimed at increasing aggregate demand. As we’ve seen, that policy was partly successful: although Japan’s economy was sluggish during the 1990s, it avoided a severe slump comparable to what happened to many countries in the 1930s. Yet the fact that Japan was running large deficits year after year made many observers uneasy. By 2000 there was a debate among economists about whether Japan’s debt was starting to reach alarming levels. No discussion of fiscal policy is complete if it doesn’t take into account the long- run implications of government budget surpluses and deficits. We now turn to those long-run implications. Deficits, Surpluses, and Debt When a family spends more than it earns over the course of a year, it has to raise the extra funds either by selling assets or by borrowing. And if a family borrows year after year, it will end up with a lot of debt.
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2 CHAPTER 12 SECTION 4: LONG-RUN IMPLICATIONS OF FISCAL POLICY The same is true for governments. With a few exceptions, governments don’t raise large sums by selling assets such as national parkland. Instead, when a government spends more than the tax revenue it receives—when it runs a budget deficit—it almost always borrows the extra funds. And governments that run persistent budget deficits end up with substantial debts. To interpret the numbers that follow, you need to know a slightly peculiar feature of federal government accounting. For historical reasons, the U.S. government does not keep books for calendar years. Instead, budget totals are kept for fiscal years, which run from October 1 to September 30 and are named by the calendar year in which they end. For example, fiscal 2004 began on October 1, 2003, and ended on September 30, 2004. At the end of fiscal 2004, the U.S. federal government had total debt equal to almost $7.4 trillion. However, part of that debt represented special accounting rules specifying that the federal government as a whole owes funds to certain government programs, especially Social Security. We’ll explain those rules shortly. For now, how- ever, let’s focus on public debt: government debt held by individuals and institutions outside the government. At the end of fiscal 2004, the federal government’s public debt was “only” $4.3 trillion, or 37% of GDP. If we include the debts of state and local governments, total government public debt was approximately 44% of GDP. Figure 12-10 compares the U.S. public debt–GDP ratio with the public debt–GDP ratios of other wealthy countries in 2003. As of 2003, the U.S. debt level was more or less typical. U.S. federal government public debt at the end of fiscal 2004 was larger than it was
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