20100921+for+20100922+Econ+1 - Economics 1: Fall 2010...

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Unformatted text preview: Economics 1: Fall 2010 J. Bradford DeLong, Michael Urbancic, and a cast of thousands... hAp://delong.typepad.com/econ_1_fall_2010/ Ladies and Gentlemen, to Your i>Clickers... •  At the moment, three of the seven seats on the Federal Reserve Board are vacant, and the chair of the Federal Reserve expresses the consensus. That means that the voPng members of the FOMC excluding the chair now consist of: –  A. Four chosen by bankers, two DemocraPc appointees, and two Republican appointees –  B. Five chosen by bankers, one DemocraPc appointee, and two Republican appointees –  C. Five chosen by bankers and four DemocraPc appointees –  D. Seven Republican appointees and one DemocraPc appointee –  E. Eight DemocraPc appointees Economics 1: Fall 2010: The Long ­Run Government Budget J. Bradford DeLong September 20, 2010, 12 ­1 Wheeler Auditorium, U.C. Berkeley $Z100,000,000,000,000 The NaPonal Debt Federal Spending and Revenue: History and Near Future Ladies and Gentlemen, to Your i>Clickers... •  Historically, before 1980, the U.S. debt ­to ­GDP raPo rose: –  A. Only in wars –  B. Only in great depressions –  C. Only in wars and great depressions –  D. Even in prosperous peacePme Federal Spending and Revenue: Longer ­Term Outlook The “Current ­Law Baseline” Is Close to Balanced •  Primary fiscal gap of 1.2% of GDP over the next 25 years •  But the CBO does not believe congress and the president will sPck to the current ­law baseline –  –  –  –  –  –  –  “Middle class” tax cuts (0.7%) High bracket tax cuts, estate tax, etc. (0.6%) “AMT fix” (0.3%) “doc fix” (0.2%) R&D credit (0.1%) Special tax on high ­cost health plans (0.8%) iPAB (0.9%) •  AlternaPve fiscal scenario: primary fiscal gap of 4.8% of GDP What Happens If a Government Loses the Confidence of Its Creditors? •  Zimbabwe •  Four lesser examples: –  –  –  –  Mexico 1995 East Asia 1997 ­1998 ArgenPna 2001 ­2002 Greece 2010 •  Are we close to the edge now? –  No •  Will we be someday? –  Perhaps •  When? –  We don’t know... Ladies and Gentlemen, to Your i>Clickers... •  Why did the U.S. debt ­to ­GDP raPo rise from 1981 ­1993 and from 2001 ­2007? –  A. Because of big wars –  B. Because of great depressions –  C. Because of wars and great depressions –  D. Because the Republican Party decided to play Santa Claus –  E. Because the DemocraPc Party forced the Republican Party to unbalance the budget The Debt EquaPon •  (D/Y)t = dpt + (1 + r – g)(D/Y)t ­1 •  The debt ­to ­GDP raPo this year is equal to the primary deficit + the debt ­to ­GDP raPo last year Pmes the sum of one plus the real interest rate on government debt minus the growth rate of the economy •  Solve for the stable debt ­to ­GDP raPo: –  Stability: (D/Y) =  ­dpt /(r – g) •  If r > g, there had beAer be a primary surplus... •  If r < g, what is the problem? •  But will r < g? –  If people lose confidence in your government—if r goes up—then you can get into big trouble immediately What Does Big Trouble Look Like? Ladies and Gentlemen, to Your i>Clickers... •  What is the most likely outcome for the U.S. budget come 2060? –  A. We will have raised taxes to pay for government health spending. –  B. We will have cut doctors wages and enslaved them by draring them into a socialist naPonal health service. –  C. We will have abandoned our commitment to providing state ­ of ­the ­art health care to the sick and not just the wealthy. –  D. The health care fairy will have figured out a way for us all to have all the medically ­appropriate care we need for a surprisingly low private and public budgetary cost. –  E. The federal government as we know it will have collapsed, and those of us sPll alive will be starring involuntarily in a remake of “Mad Max: Beyond Thunderdome” Economics 1: Fall 2010: The Government Budget in the Medium Run J. Bradford DeLong September 20, 2010, 12 ­1 Wheeler Auditorium, U.C. Berkeley Suppose That We Are Not in a “Depression Economics” SituaPon... •  •  •  •  •  Y = Y* Y = C + I + G + NX C = c0 + cyY Y* = c0 + cyY* + I + G + NX (I + G + NX + c0) = Y*/(1 ­cy) –  If G goes up—and if nothing happens to c0—then I and NX will go down –  Do we like having I and NX go down? Probably not... How Do NX and I Fall? •  NX: Government issues more bonds Bond prices fall in dollars Interest rates rise More foreigners who have sold us imports decide not to by exports but instead to take advantage of the higher interest rates and buy bonds –  NX falls –  –  –  –  •  I: Government issues more bonds Bond prices fall Interest rates rise Businesses that were planning to borrow more and invest and expand their capacity decide not to do so –  I falls –  –  –  –  •  Unless we really want to shrink I or NX... –  Expansions of G should be accompanied by steps to diminish c0 –  What are those measures? –  Generally tax increases... Nobody Likes Tax Increases... •  But we have to do them eventually –  Or else debt crises and hyperinflaPon... •  What if we postpone them? –  A good reason to postpone them: depression economics—a cyclical deficit is a good thing –  But if we are not in depression economics, postponing deficits lowers NX and lowers I •  Hence two rules –  Balance over the business cycle –  Milton Friedman’s PAYGO Are These Rules Sustainable? •  James Buchanan’s criPque: –  “cyclical deficit in downturns good, permanent structural deficit bad” is just too complicated for the poliPcal system to process –  Hence tolerate and approve of cyclical deficits to fight downturns –  And you are sewng the poliPcal stage for permanent structural deficits –  That will slow growth –  And possibly lead to financial crises and hyperinflaPon Is Buchanan Right? •  The possibility seems distressingly likely •  The number of excuses to avoid tax increases is infinite... •  The number of ways since 1980 that people— usually Republicans—have found to try to permanently unbalance the government budget in the long run is truly astonishing... –  The “Laffer Curve”: cut taxes and actually raise tax revenues: •  •  •  •  Works in some “depression economics” situaPons Works with tariffs Works when the taxes are just the levers for corrupt extorPon In the North AtlanPc? Not so much... –  A Laffer coefficient of 1/10 is what you should keep in the back of your mind Never Trust the Wall Street Journal WSJ Forecasts 06: no housing bubble 07: subprime crisis will not spread 08: we aren’t in recession 09: high inflaPon is coming 10: high interest rates are coming Test Your Knowledge •  When in American history has the debt ­to ­GDP raPo risen? •  What happens when a government’s creditors— the bondholders—conclude that a government might never close its fiscal gap? •  What is the CBO’s budget baseline—the thing that shows only a small fiscal gap (1.2% of GDP) over the next 25 years? •  So our budgetary situaPon right now is fine— except that we want to run short ­term deficits in order to reduce cyclical unemployment—right? We Don’t Need Another Hero... ...
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This note was uploaded on 07/15/2011 for the course ECON 1 taught by Professor Martholney during the Fall '08 term at Berkeley.

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