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Unformatted text preview: CHAPTER NINETEEN BUDGET DEFICITS AND THE PUBLIC DEBT INSTRUCTIONAL OBJECTIVES After completing this chapter, students should be able to: 1. Differentiate between deficit and debt. 2. Explain each of the three budget philosophies. 3. Identify the principal causes of the public debt. 4. State the absolute size of the debt and the relative size as a percentage of GDP. 5. Describe the annual interest charges on the debt, who holds the debt, and the impact of accounting and inflation on the debt. 6. Explain why the debt can also be considered public credit. 7. Identify and discuss two widely held myths about the public debt. 8. Explain the real or potential effect of the debt on income distribution, economic incentives, fiscal policy, and private investment. 9. Sketch two scenarios of government deficit financing and the effect of each on present or future generations. 10. Describe how budget deficits are related to trade deficits. 11. Identify two recent policy responses to the deficit and two proposed remedies for future deficits. 12. State how debt plays a positive role in society. 13. Define and identify the terms and concepts at the end of the chapter. LECTURE NOTES I. Definitions of deficit and debt A. A budget deficit is the amount by which governments expenditures exceed its revenues during a particular year. B. The national or public debt is the total accumulation of the Federal governments total deficits and surpluses which have occurred through time. C. State governments have a collective budget surplus. II. Three Budget Philosophies A. The annually balanced budget was the goal until the 1930s Depression, but this philosophy rules out using fiscal policy as a countercyclical, stabilizing force. 1. In a recession, the government would have to raise taxes and lower spending to balance the budget as tax revenues fell with recessionary income levels. This policy would worsen recession. 239 Budget Deficits and the Public Debt 2. In an inflationary boom period, a balanced budget would intensify the inflation. As tax revenues increased, the government would need to cut taxes or raise spending to avoid a budget surplus. This strategy would make the inflation worse. 3. The balanced budget is not neutral, but is procyclical, that is, it worsens the business cycle. 4. Those who argue for the annually balanced budget want to limit the growth of government. B. The cyclically balanced budget is also a conservative spending philosophy which allows for some government stabilization policy over the length of the business cycle. Deficit spending is allowed during a recession, and surpluses during an inflationary period. C. Functional finance is the third budget philosophy. Advocates argue that the budget is secondary, but the primary purpose of Federal finance is to achieve noninflationary full employment. Government should do what is necessary to achieve this goal regardless of the deficit or surplus in the budget. Proponents offer several responses to critics.Proponents offer several responses to critics....
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