Economics 201, Witte, Tuesday, November 1, 2005
Announced tonight by e-mail.
Aplia is misbehaving a bit for me.
Second Exam in one week.
Calculator, photo ID.
TB Keynes, K&W 9 (again), 10, 11,
Limits to AD stimulation
The simple formulas 1/(1-MPC) and –MPC/(1-MPC) overestimate the real impact of the
Some of the stimulus is taken away by taxes.
Some of the stimulus goes abroad to the extent that the increased spending is for foreign goods.
Some of the real impact of the rise in nominal AD is lost due to rising prices.
There is an maximum limit to what can be produced in real terms.
“Banana” shape of AS curve and rising price levels going with rising AD.
Government Debt = Sum of all previous deficits and surpluses
Public debt = private wealth, paying it off largely means taxing and paying ourselves.
Rolling over of debt, and interest expense.
How big is too big?
Debt/GDP ratio is interesting, but highly variable.
16.3% in 1929, 108% in
1946, 26.2% in 1976, 25.4% in 1980, 42.1% in 1988, 47.5% in 1992, 35.8% in 2002.
Currently right about 50% of Nominal GDP.
Do we need to balance the budget?
If NGDP grows by 5%, which is reasonable, then the debt can grow by 5%
and keep the Debt/GDP ratio constant.
That would be a deficit of $275 billion.
However…the deficit is likely to be in excess of $500 billion.
Perverse incentives to this
sort of calculation.
Deficit goes up, stimulates AD, gets us a bigger real economy and more Id.
Crowding out (more likely):
Deficit goes up, little effect on RGDP but bids up interest
rates and competes away funds for Id.
Fighting the “crowding out” effect of rising interest rates by increasing the money supply
(“monetizing the deficit”) is a recipe for terrible inflation.
Balance “high employment” budget.
Since tax revenues vary with the
cyclical level of the economy, we can ask, “Would the budget be balance if the economy
were at 5% unemployment?”
“Money is a machine for doing quickly and commodiously what would be done, though
less quickly and commodiously, without it.” – John Stuart Mill
Money has three classic roles that if fulfills – useful social invention
Money is a medium of exchange.
Great way to trade goods, way better than barter
with its “dual coincidence of wants” problem.
Money is a store of value.
Do notice that money is just one part of wealth, but it’s the part that is most
“liquid, most easily spent.
When I bought an old car once for $1, my
money went down by $1 but my wealth stayed the same since I now had a
car worth $1. Similarly, I could borrow $100 which would increase my
money holdings by $100 but since my debt would have risen by $100, my
new worth or wealth would stay the same.