What Demonstration The $3. 1-trillion budget, which would more than double the deficit, takes on board the stimulus package just passed by the Congress. This increase reverses the budget improvement of the past three years. Though this package was passed in order to prevent the U. S. economy from going into recession, its long-term effects are just that of a complete crowding-out, where investments would decrease. On the other hand, this will not affect the GDP in the long-run, but this will just increase the deficit as government spending increases.
Not only the fiscal stimulus is obviously a factor behind this years surge in deficit, this also reflects a weaker economic growth and a decrease in tax revenue. Despite that, the Administration insists that the deficit jump is temporary and that U. S. will be operating in the black (Gosselin, 2) for the first time in a decade. Reaching balance in 2012 by cutting on wasteful spending (Budget, 3) is the highlight in the Presidents 2009 Budget. This plan reduces domestic spending on Medicare, huge health insurance program for the elderly, Medicaid and the state-federal health program for the poor (Gosselin, 2).
They believe that one of the benefits of tax cuts is that it will keep government spending in check (Becker 3). They also assume that the tax cuts will expire at the end of 2010. This will cause an increase in taxes. And since public saving equals the taxes minus government spending, the increase in taxes would cause the deficit to decrease. But these are optimistic assumptions which are unlikely to happen like that Congress will drop its temporary relief from the Alternative Minimum Tax (Gosselin, 2) wherein reality tax revenue will most likely drop in the short-term as many believe the nation may already be in a recession.
(Weisman, 3) How Complication In reality government spending is likely to increase due to understated war costs and the failure to freeze domestic spending. First the administration assumes only $70 billion in costs for Iraq in Afghanistan wars next year, a fraction of the true costs (Weisman, 3). They also assume that beyond 2009, the budget includes no war costs at all. (Weisman, 3) Secondly, the plans to freeze domestic spending will likely face stiff opposition in Congress. So a decrease in government spending is unlikely as it drew the sharpest criticism from leading Democrats.
(Gosselin, 2) With the assumption that the U. S. is a large open economy, the increase in government spending would cause national saving to decrease, thus decreasing the worlds saving by a little. This will then decrease the worlds interest rates slightly, which will also decrease investments in the U. S by a smaller portion than the decrease in their national saving. This decrease in the Net Saving (S-I) will cause our real exchange rate or the relative prices of our goods to increase in order for foreigners to buy less of our goods.
Our nominal exchange rate will then increase due to the rise in the real exchange rate resulting in a drop off in Net Exports. At the same time, the budget seeks to make the tax cuts permanent which would have a positive impact on long term growth. In the long run, the GDP is only affected by changes in technology and resources. One of the benefits of low taxes is increased labor productivity. This is important because investment in human capital is responsive to take-home pay and therefore to tax rates (Becker, 3). Lower taxes will also provide incentives that will make the labor force more productive in the long run.
As a result GDP will increase. At the same time, if workers are more productive, firms would want to hire more of them at any given wage. After the increase in labor demand the equilibrium wage will fall, but the number of people employed will remain the same since labor supply is fixed in the long run. Thus unemployment will not be solved. Changes in the price level cannot be determined because we do not know what is happening to the money supply. Why Implication The budget is clearly trying to postpone the long term impacts to the budget balance. It is an election year, so they might be trying to make the administration look better.
They are putting off and hiding under the rug. (Weisman, 1) In the future, fiscal problems will plague the economy. Our deficit is currently being funded by foreign money through the sale of U. S. treasury. The question is how long these foreign economies will be able to finance our growing deficit as we might no longer be able to sustain these deficits. In the long run Net exports will also decrease due to an increase in government spending. This will fuel the already inflated trade deficit. This is not economically adaptive for the U. S. especially if it wants to have a sustained trade balance.