The government budget typically includes: government spending (government purchases), transfer payments, and taxation. Government spending and transfer payments cause an outflow of government funds (expenses); taxation causes an inflow of funds (income or revenue).
When government revenues exceed total government spending and transfer payments, we experience a budget surplus. When government revenues are less than total government spending and transfer payments, we experience a budget deficit. When government revenues equal total government spending and transfer payments, we have a balanced budget.
Governments often run into delays, or time lags, when they use fiscal policy to influence the economy.
A recognition lag describes a delay in the time it takes policy makers to become aware of a problem in the economy. For example, while the housing bubble grew in the United States in 2004-07, most policy makers ignored indicators that suggested housing prices were overinflated and the banking system was systematically offering risky loans to people who could not afford to repay them. Officials should not have been surprised when the housing bubble burst in 2007-08.
An implementation lag refers to a delay in the time it takes policy makers to enact a remedy for a problem. For example, Congress waited until 1964 to enact a tax cut President John Kennedy proposed in 1960 to alleviate a mild economic slowdown. By the time Congress passed the legislation, the U.S. economy was beginning to experience inflation and needed a different fiscal remedy.
An impact lag describes a delay between the time a policy is enacted and when the economy feels its impact.
Review policy lags in Chapter 11.2 Problems and Controversies of Monetary Policy from Principles of Macroeconomics.
5c: Explain how discretionary fiscal policy works and influences aggregate demand.
Fiscal policy describes the policies governments enact to influence the aggregate economy, real GDP, and the price level. Policy makers use two primary discretionary fiscal policy tools: government spending and taxation.
Discretionary spending refers to spending policies federal, state and local legislators approve or enact via the appropriations and legislative process. For example, in the United States, Congress, the legislative branch that has the "power of the purse." Congress authorizes spending to fund programs that support national defense, transportation, education, foreign aid, etc.
Congress has also passed certain automatic, mandatory, non-discretionary spending programs that they have agreed do not warrant annual authorization. These programs receive automatic, annual, funding increases. These non-discretionary spending programs include social security, Medicare, and Medicaid. Keep in mind that Congress has the power to reduce or eliminate these programs, but chooses not to.
Automatic stabilizers (reviewed in Unit 2) describe the programs Congress has legislated that automatically stimulate aggregate demand during an economic slowdown, and automatically reduce aggregate demand during a period of inflation. Examples of automatic stabilizers include unemployment and welfare benefits, and the individual and business tax rate.
Recall how we measured aggregate expenditure and aggregate demand in Unit 2:
Aggregate Demand = Consumption + Investment + Government Spending + Net Exports
Figure 12.8 Expansionary and Contractionary Fiscal Policies to Shift Aggregate Demand
In Panel (a), the economy faces a recessionary gap (YP − Y1). An expansionary fiscal policy seeks to shift aggregate demand to AD2 to close the gap. In Panel (b), the economy faces an inflationary gap (Y1 − YP). A contractionary fiscal policy seeks to reduce aggregate demand to AD2 to close the gap.
– Chapter 12.2 The Use of Fiscal Policy to Stabilize the Economy, Principles of Macroeconomics.
Review fiscal policy in the following resources.
Review the major components of U.S. government spending and their sources in learning outcome 5a above.
Review what it means for the government to project a budget surplus, budget deficit, and balanced budget in learning outcome 5a above.
Economists calculate the national debt as the sum of all past federal deficits, minus all surpluses. Government spending on the social security program, as the baby boomer generation retires en mass, is one of the largest components of the U.S. national debt.
Review the budget deficit and the national debt in the following resources.