Professor Steven Wood
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*Note: Reference to Professor Wood’s Power Point
Slides today will be noted as (19-1), for “Power
Point #19: Government Spending and its Financing
Part 2, Slide #1.”
Today, we’re back to government spending.
Yesterday, the Federal Reserve reduced the federal
funds rate to 1%, taking it back to the lowest rate
that I’ve seen since I was born, which was a long
time ago. Clearly when the central bank is reducing
interest rate, this is because they’re very concerned
that the economy is heading into a deep recession.
Given the fact that we’ve seen these interest rates
move so dramatically, the shocks that we’ve seen in
the economy are probably from the market for
goods and services. There is even a rumor that the
Fed will even lower this rate to 0%. I don’t think
they’ll go that far, but one of the things to keep in
mind is that if the Fed does push it to zero, they
can’t, so they’ll have to do something else (nominal
interest rates can’t go to zero).
Early today we got a report on how the economy
grew in the third quarter this year. Well it didn’t; it
actually shrank. The current estimate is that the
growth rate in the 4
quarter will be -3 or -4%.
Consumer spending was down 3.1%. This is very
substantial. Remember that consumer spending is
about 70% of the economy. We haven’t had this
negative shrink since 1991.
The first thing that we want to realize is that
government outlays, or government spending, is
actually composed of three things. The first is
government purchases (G). These are purchases of
goods and purchases, or the part that directly affects
economic activity. We also have transfer payments
(TR) and net interest payment (INT). Both of these
may affect economic activity, but not directly.
When we think about the kinds of things the
government buys, we can make a distinction
between government consumption services (things
they buy and use up in the same time period) and
government investment purchases (things they buy
and wait for returns). Most of government
purchases are taken over by payroll for anyone in
the public services – firemen, policemen, park
rangers, etc. But about 1/6 of government purchases
include investments such as buying trucks, vehicles,
office equipment, building offices, etc in order to
support government plans that take place. So not a
lot of what we do by government is not what we
would consider an investment activity.
TRs are expenditures for which the government