AP Econ Module 30 Deficits Debt - Sunny Hills High School

The cyclically adlustod budg8l balanc€
is an estmate of what the budget balance
would be ff real GDP were exactly oqual to
potential output.
The U.S. Federal
Budget Deficit and
the Unemployment
Rate
Itrere is a clos€ mlationship be-
twssn fiB budoet balance and
the business cycle: a rscession
moves the budget balance b-
ward dsficlt, but an expansion
moves it toward surplus. Hsre,
the unemployment rate ssrves
as an indicabr of the business
cycle, and we should expect b
see a higher unsmployment
rate a$ociat8d wilh a higher
budget deficit. lhls ls confirmed
by the figure:$e budget deficit
as a percenhge of GDP moves
closoly in tandem wih the un-
employment rate,
Sot rdr. Bumau of Economic Analysis;
Bu.eau of lalor Shtslics.
stages ofthe long expansion from 1991 to 2000, the deficir actually becarne negative_
the budget deficir became a budget surplus.
The reladonship between the business cycle and the bud.get balance is even clearer if
we cornpare the budget deficit as a percentage ofGDp with the unemplo;,tnent rate, as
we do in Figure.30.2. The budget deficic almost always rises when the unemployment
rate rises and falls when the unemployment rate fa.lls.
Is this relationship between the business cycle and the budget balance evidence that
policy makers engage in discretionary fiscal poliry? Not necelsarily. It is largely auromatic
stabilizers chat drive the relationship shown in Figure 30.2. As we learned in the
discussion of automatic stabilizers in Module 21, government rax revenue tend.s to rise
and some govemment rransfers, like unemployrnent benefit payments, tend to fall
when the economy expands. Conversely, govemment tax revenue tends to fall and
some government transfers tend to rise when rhe economy contracm, So the budget
tends to_move toward surplus during expansions and toward deficit during recessiJns
even without any deliberate action on rhe part of policy makers.
assessing
_ budget policy, it's
_In often useful ro separare movements in the budget
balance due to the business cycle from movements due to discretionary fiscal policy
changes. The former are affected by automatic stabilizers and the latter by deliberate
changes in government purchases, govemment transfers, or taxes, ICs imporcant co realize
that business-cycle effects on the budget balance are temporary: both recessionary
gaps (in which real GDP is below potential outpur) and inflationary gaps (in which real
G,DP is above porential outpur) tend to be eliminared in the long run. Removing their
effects on the budget bilance sheds light on whether the govimmenCs taxing and
spending policies are sustainable in the long run. In other words, do the government,s
tax policies feld enough revenue to fund its spending in the long run? As we,ll learn
shortly, this is a fundamentally more important question rhan whether the government
runs a budget surplus or deficit in the current year,
To separate the effect of the business cycle from the effects of orher factors, many
governments produce an estimate of what the budget ba.lance would be if there were
neither a recessionary nor an inflationary gap. The cyclically adjusted budget balance
Budget
d€ficit
(percent
of cDP)
1090
8
6
4
2
0
-4
^S
^,9'
298 section 6 lnflation, Unemptoyment, and Stabitization policies
^b
r9'
"+'
gse
g.'
g""
.L! ^ss
rts t'""
Year
Unempl.oyment
rate
(percent)
r20t"
10
8
6
4
2