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Recession, Tax Cuts and Budget Deficits.

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Introduction

Case 2: Recession, Tax Cuts and Budget Deficits 1. Executive summary 2. The 90's- Sarah a. Stock market boom b. Exacerbated inequality a. Expansion of the earned-income tax credit b. Welfare reform c. Did Clinton have anything to do with the shift to surplus? Position= deficit reduction is the best way to stimulate growth 3. The New Millenium- Russ a. Causes of mild recession in Q2, Q3, Q4 of 2001 i. Burst of the stock market bubble (stock prices) ii. Cutback in business investment a. Recession during 2001 (GDP charts) b. Higher unemployment after recession even though there is GDP growth (Unemployment charts) - jobless recovery 4. Effect of Sept. 11, 2001- TBD a. Terrorist attacks on economy b. Economic policy to fund the cost of war in Iraq- higher than expected gov't expenditures 5. Use of monetary and fiscal policy to stabilize the economy- Russ i. Monetary policy - Fed controlled interest rate (interest rate chart) ii. Fiscal policy - Bush enacted a tax cut 6. Tax cuts- Ed a. Income tax changes b. Bush's rationale i. Campaign ii. Start of recession c. Criticism of tax cut: benefits wealthiest Americans the best d. AMT e. Retroactive 2001 rebate: spend or save? 22% spent (book) 7. Return to record budget deficit a. Why do some believe deficits are a problem? Less output than expected = less savings (WSJ article)- Russ b. SS and Medicare coiffeurs- Ed i. Projected costs limit life of SS ii. Baby boomers = more retirees than workforce 8. Current economic situation?- Ed a. High unemployment b. Low inflation c. Positive GDP growth d. Jobless recovery: GDP rising but unemployment not falling? e. Productivity improvement- Y/N 9. The future... a. Election year rhetoric- Sarah i. Plans for turnaround b. Bush fiscal policy: pro or con? ...read more.

Middle

The drop in stock values meant that people lost a lot of stock wealth. The meant there was less capital available to invest in businesses. On a related note, businesses were ramping up capital investment during the 1990s to prepare for the Y2K problem. The next two figures show how the capital investment ramped up during the late 1990s and fell after 2000.3 The first figure shows the gross domestic private investment in billions starting in 1996. There was steady growth from 1996 to 2000 and then a substantial decline. The start of the decline coincides with the bust of the stock market bubble. The other figure shows the percent quarterly change in nonresidential private fixed investment starting in 1996. Except for a few quarters, there was over 10% growth in investment from 1996 to 2000. Again, coinciding with the stock market bust, there is a sizeable decrease in the private fixed investment. In fact, there is decrease in private investment starting in 2001 and extends until mid-2003. The stock market bubble and decrease in business investment helped to fuel the recession. A result of the recession was higher unemployment. The figure below shows how the unemployment decreased during the late 1990s to 4% and then rose up to 5.7% right after the recession and approached 6% in future years. Usually after a recession the unemployment rate starts to decrease and inflation starts to increase. One peculiar item about this recession and subsequent recovery is the unemployment rate is not dropping; in fact, some economists are calling this period "The Jobless Recovery" and are calling for reforms to stimulate job growth.4 The figure below shows the increase in unemployment and decrease in inflation after the recession.5 The decline in private sector jobs is greater than in any of the past three recoveries. ...read more.

Conclusion

Some people wonder what is the problem with the government running a deficit. The simplest method to see the effect of the budget deficit is to examine the following equation: (T-G)=NX-(S-I) where (S-I) is the excess private saving, (T-G) is the budget surplus and NX is the trade deficit. If the budget deficit increases, there are three ways to compensate for the increase. First, private saving has to increase. Second, excess private saving has to increase. Third, the next exports would show an decrease, which translates into more foreign borrowing. The IMF believes the large U.S. deficit is going to soak up limited savings, drive up interest rate and crowd out investment, thus slowing growth.15 In fact, the following figure shows the IMF's estimate of impact on GDP of U.S. deficits if they proceed as Bush envisions. Why do some believe deficits are a problem? Burden of government debt paying for consumption goods that yield no future benefit, i.e. weapons spending vs. hospital and park building - these costs may have immediate benefit but will become a burden to future generations. The true burden on future generations is created by government spending that is financed by deficits rather than tax revenues and pays for goods that yield no future benefits, or benefits less than their social opportunity cost - for example, meals currently consumed by members of the armed forces. Absolutely nothing is generated in the future as a rate of return, all benefits accrue in the present. Pg. 354 If the federal government creates debt to build a beneficial long-lasting project, then the rate of return on the project is available to cover the interest payments on the borrowed money. If the debt is created to pay for current consumption, there is no future return to balance the extra taxes needed to pay the interest. ...read more.

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