Chapter 11

Income security programs account for the largest amount of Federal Government expenditures. These programs include social security, health care programs, etc.

State and Local Governments receive their funds from a wide variety of taxes and sources. The Federal Government is an important source of funds for State Governments.

It is not easy to decide how the Federal Government should spent its money. Here is an estimate of projected spending. If you were making the decisions, what changes would you make ?

22 % in 1950 to

35 % in 1990

Limits to Taxation

On the average, U.S. citizens feel that they should not have to pay more than 25% of their income to support government activities.

This is the "chain reaction" effect. If the government purchases cars, auto workers have more income to purchase boats, vacations, homes, etc.

Personal Income Taxes are taxes paid by individuals on their labor and capital incomes. These taxes have averaged about 9 % of GNP for the past 20 years.

Corporate Income Taxes are taxes that companies pay on their profits. These averaged about 4 % of GNP in the 1960s. They represented only 2 % of GNP by the middle 1980s.

Indirect Taxes are taxes on the goods and services that we buy and included customs duties. These were about 1.5 % of GNP in the middle 1980's.

Social Security Taxes are taxes paid by employees and employers to finance the social security programs. These taxes increased from 3.5 % of GNP in the 1960s to over 8 % of GNP in the late 1980s.

Defense purchases accounted for about 9 % of GNP during the Vietnam War. They fell during the 1970s and increased again during the 1980s.

Transfer payments are the largest element of spending. They have increased sharply from 5 % of GNP in the 1960's to over 10 % of GNP in the late 1980s.

Interest payments were about 1 % of GNP in 1970. By the 1980s, the federal government's interest payments were over 3 % of GNP.

Tax Multiplier (Cont.)

KT = ²Y/ ²Ta = 1 - (1/ MPS)

Suppose MPC = 0.8, then the tax multiplier is 1 - (1/0.2) = - 4

If autonomous taxes increase by $1000, the equilibrium income level will fall by $4000.

The tax multiplier is less than the simple Keynesian multiplier because part of taxes come from a reduction in savings.

Q. If taxes increase by $ 10,000,000. What will happen to the equilibrium level of real GNP ?

Ans. It will FALL by $ 40,000,000

Automatic Stablizers

Automatic stabilizers are tax structures and government spending programs that cause budget deficits to grow automatically during recessions and surpluses to grow during expansions.

Induced taxes serve as a shock absorber which tend to dampen changes in income. Assume that we have a closed economy with no imports or exports.

ITEM Case # 1 Case # 2

Marginal tax rate 0.2 0.4

² in GDP = ²Y $ 1000 $ 1000

² in taxes = ²T $ 200 $ 400

² in disposal income $ 800 $ 600

MPC from ²Yd 0.8 0.8

² in C = ²C $ 640 $ 480

Fiscal Drag

When per capita income is growing progressive income taxes result in a larger portion of total income being transferred to the Government. The higher tax revenues slow down economic growth. This is called fiscal drag.

In 1964 tax rates were lowered in order to reduce fiscal drag. The result was increased growth of income and more tax revenues.

Structural Deficit

A structural deficit is an estimate of the budget deficit that tax and spending structures would yield if the economy was at full employment.

Tax Revenue is the product of the tax rate and the tax base. A Tax Rate is the percentage rate of tax levied on a particular activity. The Tax Base is the activity on which a tax is levied.

We can increase tax revenues if by cutting the tax rate by x-percent we are able to increase the tax base by a larger percentage.

Suppose the above curve represents the response of tax revenues to a change in taxes on gasoline. At first, as the tax increases so do revenues. After the tax reaches 40 percent of the gasoline price, however, quantity purchased falls by a larger percentage than the percentage increase in the tax. As a result, tax revenues fall.

Fiscal Policy History

Key Concepts: Ch. 11

Chapter 12

2. Commodity money has an opportunity cost because it can be used for something other than money. Thus there is an incentive to find alternatives to the commodity which can serve as money and which have lower opportunity costs.

Commodity Money

Convertible Paper Money is a paper claim to a commodity that circulates as a medium of exchange. This form of money goes back to the 14th century. The U.S. had convertibility of the dollar until 1971.

There is an opportunity cost associated with holding the commodity. Thus, nations try to minimize the amount of the commodity held to back the convertible paper money. The least expensive alternative is to eliminate the convertibility.

ATS Account: Automatic-Transfer Saving Account -- surplus funds are automatically transferred between checking and savings accounts.

Money Market Mutual Fund: A financial institution that issues shares redeemable at a fixed price by writing a check.

Note that more money is held in large time deposits and institutional money market mutual fund shares than the entire value of M 1.

Definitions & Concepts of what is money have changed over time -- and will continue to change. Financial institutions can be very innovative at times in finding new ways to create money -- and avoid regulations.

They serve as the mechanism by which money is transferred but they themselves are not recognized as mediums of exchange. Nor do they provide the other functions of money.

A financial intermediary is a firm that takes deposits from households and firms and transfers them to others. The major types are:

Commercial Banks

Savings & Loan Associations

Savings Banks

Credit Unions

Insurace Companies

Balance Sheet of All Commercial Banks --

Assets (Billions $)

Reserves with FED. 33.7

Vault Reserves 28.7

Liquid Assets 172.7

Investment Securities 554.4

Loans 2,021.1

Other Assets 201.4

TOTAL ASSETS 3,012.0

Liabilities ( Billions $ )

Demand Deposits 627.2

Savings Deposits 542.2

Time Deposits 951.2

Other Liabilities 891.4

TOTAL LIABILITIES 3,012.0

In 1980, Congress passed the Depository Institutions' Deregulation and Monetary Control Act. This act allowed setting up of NOW and ATS accounts at all deposit-taking financial institutions.

In addition, in the early 1980s, Congress dropped Regulation Q which placed a ceiling on interest rates that financial institutions could pay on deposits. One result was the growth of money market mutual funds.

The deregulation of financial institutions set the stage for substantial changes in the forms that people hold their money. Another was the failure of many banks and savings and loan institutions. It also allowed the development of the junk bond market which led to the most massive merger movement in U.S. history.

Minimizing the cost of obtaining funds.

Minimizing the cost of monitoring borrowers.

Pooling risks.

Creating liquidity.

The desired reserve ratio is the ratio of reserves to deposits that banks regard as necessary in order to be able to conduct their business.

The Federal Reserve can help keep the required reserves low by being willing to:

1. Lend banks money.

2. Buy securities from banks.

Initial Commercial Bank Balance Sheet

Assets

Cash and Reserves 200

Loans 900

Total 1100

Liabilities

Deposits 1000

Capital 100

Total 1100

The New Balance Sheet

Assets

Cash and Reserves 300

Loans 1300

Total 1600

Liabilities

Deposits 1500

Capital 100

Total 1600


The Balance Sheet

Initial New

Assets

Cash and Reserve 200 300

Loans 900 1300

Total 1100 1600

Liabilities

Deposits 1000 1500

Capital 100 100

The reasons why a bank may not increase its loans to utilize its excess reserves include:

1. The available potential loans may be too risky.

2. The bank may believe that interest rates will go up shortly. If so, it would be wise to delay making loans until rates increased.

Real World Money Multipliers are usually less than the simple money multiplier because not all the loans made by banks return to banks in the form of reserves. Part of the loans are held in the form of currency and not re-deposited in banks.

Money Multipliers: 2

The potential money multiplier, Mp , indicates the total demand deposits that can be generated from a new bank deposit that is "fully loaned out," if people keep all of their currency in the bank.

Money Multipliers: 3

If you held $50,000 in the 1st World Bank of Ames and I told you that it was expected to fail within the week, would you be very concerned about the safety of your money ?

Chapter 13

The Federal Reserve System has three key elements:

1. Board of Governors

2. Regional Federal Reserve Banks

3. Federal Open Market Committee.

The minimum reserves that a bank is permitted to hold are called required reserves. (These average about 3 % of a bank's deposits.) By increasing required reserve ratios, the FED can create a shortage of reserves for the banking system and reduce the amount of bank leading. This will push up interest rates and reduce the money supply.

Changes in required reserves are not used as an active tool for achieving short-run variations in interest rates and the money supply. They are more commonly used to achieve long-term changes.

By lowering the discount rate, the FED can encourage banks to borrow more reserves. This will push interest rates down and increase the money supply.

Changes in the discount rate will only have an effect if the banking system is short of reserves. Increases in the discount rate signal that the FED wants to tighten up on the money supply. Reductions in the discount rate signal that the FED wants to increase the money supply.

Changes in the Discount Rate signal the direction the FED plans to go. Changing the Discount Rate alone will have limited impact on the money supply and interest rates.

Open market operations are the KEY monetary tool available to the FED.

They can have a rapid and significant impact on the money supply and interest rates.

Item Amount

Assets

Gold & Foreign Exchange 16.5

U.S. Government Securities 232.7

Other Assets 35.2

Total Assets 284.4

Liabilities

Federal Reserve Notes 224.5

Banks' Deposits 40.0

FED's Monetary Base 264.5

Other Liabilities 19.9

Total Liabilities 284.4

FED buys $ 100 in U.S. Government Securities

Fed's Balance Sheet Changes

Assets -- U.S. Govt. Securities increase by $ 100

Liabilities -- Banks' Reserves at FED increase by $ 100.

Commercial Banks Balance Sheet Changes

Assets -- U.S. Govt. Securities decrease by $ 100

Assets -- Banks' Reserves with FED increase by $ 100.

Liabilities -- no changes.

1. FED buys U.S. Government Securities.

2. Commercial Banks have excess reserves.

3. Banks make new loans.

4. New loans are used to purchase products.

5. Households' & firms' receipts increase.

6. Part of receipts are held as currency.

7. Part of receipts are deposited in banks.

8. Banks reserves go up by amount of deposits.

9. Desired reserves increase.

10. Excess reserves decrease.

11. Money supply increases by amount of currency drain ( #6 above ) and the increase in bank deposits.

Let MB = the Monetary Base

Then:

M 1 / MB = 3

M 2 / MB = 12

M 3 / MB = 14

Money Multipliers change over time but usually do not change very rapidly. They are fairly stable because:

1. The currency holdings of households and firms as a fraction of total deposits do not change very much over time.

2. The reserve holdings of banks as a fraction of total deposits do not change much.

Intermediate Targets

1. Interest Rates

2. Quantity of Money ( M 1 & M 2 )

Both the FED and the U.S. Treasury are concerned about the U.S. balance of payments and international flows of funds. If U.S. interest rates are low relative to interest rates elsewhere the result will be a flow of funds out of the U.S. The FED, in particular, wants to avoid rapid movements of international funds.

The FED controls the supply of money. Households and firms determine the demand for money. This is the primary reason why the FED can't control both interest rates and the money supply.

Alternatively, the FED can set the quantity of open market sales or purchases of U.S. securities. In this case the rate of interest changes as the price of securities is allowed to adjust to clear the market. This is referred to as base control because the FED is viewing the monetary base as the primary policy instrument.

1951 -- 1969

The FED tried to control interest rates, keeping in mind that it wanted to exercise some control over the money supply.

1970 -- 1990

The FED gave more attention to regulating the money supply and less to the control of interest rates. In the early 1980's, the FED made absolutely no effort to control interest rates.

For the 1960 -- 1990 period to observe:

1. The rate of monetary expansion has shown major short-term swings.

2. There has been a strong upward, long-term trend in the rate of growth of the money supply.

3. Monetary policies have tended to be "jerky." Monetary expansion frequently has varied from full-halt to full-speed.

Suppose that unemployment was projected to be 8 % next year. What actions would you expect the FED to take ? How would the anticipated actions of the FED affect your decision:

to purchase a home ?

to switch money in your checking account to a three year CD.

Paul Volcker was Chairman of the Federal Reserve System from August, 1979 until August, 1987.

One of his first actions was to tighten up on the money supply. Real interest rates were very low ( and at times even negative ) in the 1970's. Volcker was determined to change that and to bring an end to high rates of inflation. He achieved this by slowing down the rate of growth of the money supply. The equation for achieving this was very simple.

Outline the FED's structure.

What are the main monetary policy tools the FED uses to influence interest rates ?

Explain what happens the balance sheet of commercial banks when the FED purchases U.S. securities on the open market.

Show how to calculate the money multiplier for M 2.

What factors influence the aggregate quantity of money demanded ? Explain the relationships between these factors and the demand for money.

You should be able to:

Explain what money is.

Distinguish between the various types of money.

Define "Excess Reserves."

Explain the Quantity Theory of Money.

Calculate the Simple Money Multiplier.

Be able to place items on a bank's balance sheet.

And be able to answer the following:

What are the functions of money ?

How do banks create money ?

What is the significance of Gresham's Law ?

Are bank loans an asset or a liability ?

During the 1980's, there were several occasions when the FED tried to reduce the value of the dollar in terms of foreign currency. Why ?

Chapter 14

Transaction Demand

The main motive for holding money is to be able to undertake transactions and to minimize the cost of transactions. ( Suppose you put everything you earned in CDs as soon as you were paid. Would it be expensive for you to go shopping ? )

Households' and firms' demand for money is influenced by:

These influences translate into three macroeconomic variables that influence the aggregate quantity of money demanded.


Real GNP is an important determinant of the quantity of real money demanded. As Real GNP increases, the demand for real money increases.

The Demand for Real Money is the relationship between the quantity of real money demanded and the interest rate, holding constant all other influences on the amount of money that people wish to hold.

The growth of real income in the United States has resulted in an increase in the demand for real money. On the other hand, financial innovation has:

created new ways to hold money.

made it easier for us to move between various types of money.

increased the velocity of existing money, which in turn decreased the demand for real money holdings.

The Quantity Theory of Money states that:

M V = P Y

therefore

V = Y / ( M / P )

In other words, the velocity of circulation is equal to the ratio of real GNP to the real money supply, ( M / P ).

Classical Quantity Theory

M V = P Yf

If the money supply increases, prices go up. There is a direct relationship between the rate of change in the money supply and the rate of change in prices.

²M / M = ² P / P

Suppose the current interest rate is 5 % and the perpetuity pays $ 10 a year.

The perpetuity is therefore worth:

P = $ 10 / 0.05 = $ 200

If the interest rate increases to 10 % annually, the value of the perpetuity falls to:

P = $ 10 / 0.10 = $ 100

A flow equilibrium is a situation in which the quantity of goods or services supplied per unit of time equals the quantity demanded per unit of time.

Market interest rates are determined by the supply of and demand for money.

The FED and commercial banks determine the supply of money.

Households and firms determine the demand for money.

For example, growth of money market mutual funds in the 1970's was overlooked. The FED increased the supply of conventional money and thereby caused inflation to increase.

In other words, the Transmission Mechanism describes:

1. The link between monetary equilibrium (Ms = Md) and the interest rate (r).

2. The link between the interest rate (r) and investment (I).

3. The link between investment (I) and aggregate demand (AD).


As interest rates fall; investment increases. The relationship between the interest rate and investment is called the:

MARGINAL EFFICIENCY OF INVESTMENT.

As Aggregate Expenditures increase, the Aggregate Demand curve shifts to the right and income (Y) increases.

1. The steeper the LP function, the greater the effect of a change in the money supply on interest rates.

2. The flatter the MEI function, the greater effect a change in the rate of interest will have on investment expenditure and hence on aggregate demand.

The degree of sensitivity of investment to interest rates depends on how willing people are to vary the timing of their investments. If investments are easily postponed, then the MEI of investment function will be very flat. i.e. Investment will be very sensitive to changes in interest rates. A small change in interest rates will result in a large change in investment.

When the LP function is steep and the MEI function is flat, a small change in the money supply will result in a large change in investment -- and therefore in national income. In this case, monetary policy works very well.

When the LP function is flat and the MEI function is steep, a very large change in the money supply will result in only a small change in the level of investment. In this case monetary policy does not work very well.

Autonomous Expenditure Lag

Investment is an "autonomous" variable in aggregate expenditure. Changes in interest rates affect investment plans over a period of time. Some investment decisions are very responsive to interest rate changes. Others are not. Thus there is a lag in the effect of interest rate changes on autonomous expenditures.

Price Adjustment Lag

This lag occurs if a change in equilibrium expenditure changes prices. In the "intermediate" range of the aggregate supply curve, an increase in aggregate demand will begin to push up prices. After a period of time, the higher prices will result in higher production costs and the short-run aggregate supply curve will move upward. This price adjustment process takes place over a period of time -- i.e. with a lag.

In addition to the "interest rate" transmission mechanism, there are three other important transmission mechanisms of monetary policy. These are the:

Real Balance Effect.

Wealth Effect.

Exchange Rate Effect.

Sequence of events:

1. Money supply increases.

2. With prices constant, real money holdings increase.

3. People convert part of their real money holdings to other types of assets.

4. As a result, investment increases.

5. As investment increases, real GNP goes up.

Sequence of events:

1. Money supply increases.

2. People use the money to buy stock.

3. As stock prices go up people become wealthier.

4. As wealth increases, people spend more on goods.

5. As consumption increases, real GNP goes up.

Sequence of events:

1. Money supply increases lower interest rates.

2. As U.S. interest rate fall, investors purchase higher yielding foreign assets.

3. In the process they sell U.S. dollars and buy foreign currency.

4. This lowers the value of the U.S. dollar relative to the values of foreign currency .

5. As the exchange rate falls foreigners buy more U.S. goods. The increase in exports results in an increase in real GNP.

When the government increases its purchases of goods and services, autonomous expenditure increases and the increased equilibrium expenditure brought about by the subsequent multiplier process increases real GNP.

This increase in real GNP leads to an increase in the demand for real money.

As a result, interest rates go up and private investment falls.

In other words, the increase in government purchases of goods and services crowds out private investment.

Keynesians believe that the Crowding -- Out Effect is small. Fiscal policy works well -- at least when there is a large GNP gap.

Monetarists believe that the Crowding - Effect is large. Fiscal policy does not work well.

The FED favors keeping Government purchases down and taxes high enough to avoid a deficit. This would take the pressure off the FED to keep interest rates low and to help finance the Government's deficit.

Congress, on the other hand, wants the FED to steadily expand the money supply and thereby keep interest rates as low as possible.

Neither wants to dance to the other's music.

In the 1980's, the Government deficit increased very rapidly. This resulted in higher real interest rates which in turn attracted foreign funds to help finance the deficit. The inflow of foreign funds helped keep the inflation rate down. On the other hand, the dollar remained relatively strong -- which resulted in lower exports and higher imports. Thus the U.S. trade deficit increased substantially.

It takes time to:

1. Identify changes in GNP and prices.

2. Analyze what needs to be done.

3. Make a decision.

4. Implement the decision.

5. See the results.

6. Adjust the policies.

Keynesians are macroeconomists who's views about the economy are based on the theories of John Maynard Keynes. ( Keynes's " General Theory ... : 1936 ") Keynesians regard the economy as inherently unstable and as requiring active government intervention to achieve stability.

An economy is in a Liquidity Trap if the demand curve for real money is horizontal. In this situation, a change in the quantity of money affects only the amount of money held. It does not affect interest rates. Thus, even if investment responds to interest rate changes, monetary policy would not be effective. Extreme Keynesians believe that liquidity traps exist.

An extreme monetarist believes that a change in Government purchases or taxes has no effect on GNP -- and that a change in the money supply has a large and predictable effect on GNP. This could happen if:

the investment demand curve was horizontal.

the demand curve for money was vertical.

The Intermediate Position is that both monetary and fiscal policy affect aggregate demand.

Crowding out is not complete.

There is no liquidity trap.

Investment does respond to interest rate changes.

Money demand responds to interest rate changes.

The IS curve shows combinations of real GNP and interest rate at which aggregate planned expenditure equals real GNP. In other words, the IS curve shows combinations of the interest rate and real GNP at which there is an expenditure equilibrium. ( The Hicks' IS Curve was for a closed economy in which investment, I, was equal to savings, S. )

Each of the equilibrium points relating AE and real income are associated with a different interest rate.

The LM curve shows the combinations of real GNP and interest rate at which the quantity of real money demanded equals the quantity of real money supplied. ( The Hicks' LM Curve was for a closed economy in which the liquidity preference, L, was equal to the supply of money, M. )

As the equilibrium level of real GNP increases, the money demand curve ( Md ) shifts upward to the right. As a result, the supply of money is equal to the demand for money at a higher interest rate. The LM Curve shows the combinations of interest rates and real GNP which are consistent with equilibrium in the money market. We note that there are a large number of combinations of interest rates and real GNP which are consistent with equilibrium in the money market.

Suppose the market interest rate is above the equilibrium interest rate. What will happen ?

Investment will begin to fall. This will reduce GNP. As a result, the demand for money falls. This results in a lower interest rate. The process continues until we reach a combination of interest rate and real GNP which is consistent with equilibrium in the money market and in the product market.

The FED determines the money supply in current dollars. The higher the price level, the lower is the real value of those dollars. Because the price level affects the quantity of real money supplied, it also affect the LM curve. As prices fall, the Ms curve shifts to the right. This results in lower interest rates and higher real GNP. As a result, the LM Curve moves to the right.

We can derive the Aggregate Demand Curve from the IS and LM Curves. There is a different LM Curve for each price level.

All of the points on the Aggregate Demand Curve are consistent with equilibrium in the money market and equilibrium in the product market.

We introduce the Aggregate Supply Curve to determine the equilibrium price level.

Key Concepts: Ch. 14

Chapter 15

We need to distinguish between the Government Debt and the Deficit.

The Deficit is a flow.

Surplus/Deficit = Taxes -- Govt. Expenditures

The Government Debt is the total amount of borrowing the Government has undertaken over a period of years. It is a stock.

The federal government's deficit was usually less than 1 % of GNP during the 1960s. It began to grow in the early 1970s and by 1975 exceeded 4 % of GNP. Then it declined until 1980. During the 1980s the deficit averaged about 4 % of GNP.

Each 1 % point increase in the unemployment rate increases the deficit by $30 billion.

Each $100 billion decrease in current dollar GNP increases the deficit by $35 billion.

Because of inflation, the Government's deficit is not really as big as it appears. When we look at the Real Deficit, we find that it was usually positive during the 1960s and 1970s. Only when inflation declined in the 1980s, while interest rates remained high, did a large and persistent real deficit emerge.

Debt Financing: If the bonds are purchased by firms, households, or others rather than the FED, they do not bring a change in the money supply.

This would be similar to an individual borrowing money to purchase a home and then never paying anything on the principal and borrowing more money each year to pay the interest on the loan. For a $100,000 home loan at 10 % interest, you would owe the bank $121,000 at the end of the second year. Your bank loans would add up to $417,724 at the end of 15 years. Of this amount, $100,000 would be your original "deficit" and $317,724 would be the interest on the initial loan plus the interest on the interest, on the interest, on the interest.

Thus, money financing benefits the Government but it causes inflationary problems for everyone else.

Furthermore, with a progressive income tax structure, inflation results in everyone paying a higher percentage of their real income to the Government. This benefits the Government but hurts everyone else.

Item Year 1 Year 2

Inflation rate 10 % 10 %

Nominal Income $ 25,000 $ 27,500

Real Income $ 25,000 $ 25,000

Nominal Taxes $ 2,500 $ 3,000

Real Taxes $ 2,500 $ 2,727

Taxes as % of Income 10 % 11 %

With continued debt financing, the deficit becomes larger and larger. At some point, the Government debt outstanding will have grown so large that the interest burden on it will be larger than the Government is willing to pay. At that point, the Government will switch to money financing. The result will be rapid inflation. When that happens interest rates will go up and the value of the bonds that households and firms purchased earlier will lose value rapidly. Hence, Government bonds must carry an increasingly higher interest rate to encourage people to buy them. -- This results in even greater deficits. Furthermore, if people expect the value of money to fall, they will begin to switch into real goods, aggregate demand will increase and even more inflation will occur.

In summary, money financing is certainly inflationary. Debt financing could eventually become inflationary if people begin to expect that the Government will increasingly turn to money financing.

Deficits are not inevitably inflationary. But the larger the deficit and the longer it persists, the greater the pressures and temptations to cover the deficit by creating money, thereby generating inflation.

Govt. Budget Constraint

G = T + ²B + ²MB

Deficit = G - T = ²B + ²MB

If (G - T) > 0 then the government must borrow ²B > 0 or create money ²MB > 0.

One view is that the nation must increase taxes on future generations in order to pay the interest on the debt. Those who pay the taxes are not necessarily the same as those who receive the interest. The taxes tend to be on middle class wage and salary earners. The interest tends to be paid to be upper middle class, wealthy individuals and large companies. Foreign lenders are also helping to finance a larger portion of the national debt. Thus a large debt is likely to result in some re-distribution of income.

Real interest rates in the U.S. in the 1980s were higher than at any time in history. Furthermore, there is a general tendency for real interest rates and the real deficit to fluctuation together. i.e. The recent data tends to support those economists who believe in the crowding out effect of higher deficits.

Trade Deficits

G + I + X = S + T + M

(G - T) = (S - I) + (M - X)

If S = I and (G - T) > 0, then we have (M - X) > 0

In other words, we can not solve our balance of payments problem until we solve our federal deficit problem.

c. When an economy is near full employment a deficit causes inflation which hurts purchasing power and the balance of trade.

Remeasuring Public Debt

revised to conform to Generally Accepted Accounting Principles. (This would take into account the government's assets as well as its debts.)

Many elements of Government expenditure have a built-in tendency to increase. This is particularly true for income security and health care expenditures. Only by removing from the public domain certain responsibilities can the Government's share of GNP be effectively contained. Congress frequently tries to move some items "off-line " or to privatize them.

There is little scope for significant cuts in Government expenditure as long as we maintain our global defense obligations and our obligations under social security and other programs such as welfare, unemployment, Medicare, etc.

Budget Acts

The feasible alternatives available to a nation depend partly on the form of government and the size, wealth and technology of the nation.