To: Professor Hector Morales
From: Pamela Proge
Principles of Economics- Market and the Economy
Explain how an increased federal budget deficit resulting from a recession can actually help stable an economy? Deficits and debt will rise to unparalleled levels in coming decades without major changes in federal budget policies, so legislators should set a goal of alleviating the debt as a share of gross domestic product over the next decade. Reducing deficits in the short term, however, would undercut the insubstantial economic recovery. Representatives should tolerate large deficits over the next several years in order to preserve a strong aggregate demand until the economy is ...view middle of the document...
For one thing, political limitations on the amount of pain that can be delivered in a single dose would make it improbable that a single package large enough to put the budget on a sustainable long-term path in one fell pounce could be enacted. Just as importantly, indecision about key factors notably about the economy’s path and the future growth of health care costs mean that we cannot judge now the best way to solve the long-run problem once and for all. Nevertheless, policymakers should start soon to work on major policy changes.
The large temporary deficits created by the economic downturn, and the policies enacted in response, have focused welcome attention on the nation’s short- and long-term fiscal situation. Policymakers face hard choices about how to address growing deficits and debt. This paper lays out the main drivers of our long-term fiscal problem and discusses a reasonable goal for attaining fiscal sustainability stabilization of the nation’s debt. The two main bases of rising federal expenditures over the long run are rising per-person costs throughout the U.S. health care system both public and private and the aging of the population. Together, these factors will drive up spending for the “big three” domestic programs: Medicare, Medicaid, and Social Security. Growth in those programs accounts for all of the increase in federal spending as a share of GDP over the next 40 years and beyond. With a national debt of about $14 trillion, it is clear why this issue has assumed such political and economic significance. Yet, there are some popular misconceptions both in terms of meaning and importance. For starters, debt is sometimes confused with the term deficit. A deficit is where spending exceeds revenues for one year. A surplus is the opposite: revenues exceed spending. The gross federal debt is the accumulated total of annual deficits and surpluses over the course of years. During a recession, federal revenues typically fall, since most revenues are based on income. But even though revenues fall, most economists argue that during a recession, the government should spend more. This is called "deficit spending" and it is meant to stimulate economic activity. For example, imagine that the government repaired some schools and constructed some new ones. Construction companies would hire more workers and purchase machinery, tools and materials from other businesses. Those businesses would also hire more workers and purchase materials from other businesses. Construction workers would have employment and would spend their income on household goods, entertainment, and so on. More jobs and more spending are generated. This process is known as the multiplier effect. An increase in government spending leads to more economic activity than the original increase.
Economists also argue that during a strong economy, revenues will increase because of low unemployment and rising income, as is frequently the case during economic booms. On the other...