[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

revenues match expenditures. In 1998, for example, both U.S. federal government
receipts and expenditures were roughly $1.7 trillion. Now suppose that the government
increases its expenditures, say, by $100 billion. To pay for these expenditures,
suppose the government increases taxes by an equal amount. We would describe
this as a balanced budget change in taxes and expenditures. Since both expenditures
and revenues increase by the same amount, the government’s overall budget remains
in balance. What will be the effect on the macroeconomy of such a balanced budget
increase in spending?
Since taxes have risen by $100 billion, the private sector’s disposable income—
income after paying taxes—has been reduced by $100 billion. When disposable
income falls, households typically adjust by reducing both their consumption
and their saving. For example, to pay the additional $100 billion in taxes, total consumption
might fall by $90 billion and saving by $10 billion. The reduction in
consumption and saving totals $100 billion, the amount that households needed to
pay the higher taxes.
The reduction in disposable income from the tax increase reduces private saving.
Since public saving is unchanged (remember, expenditures and taxes were increased
by the same amount), national saving falls. In the capital market, the national saving
curve shifts to the left. With an unchanged investment schedule, the equilibrium
real interest rate rises and the equilibrium investment level falls. This is an important
conclusion. Equal changes in government revenues and expenditures—
balanced budget changes in taxes and expenditures—affect investment and the real
interest rate. A balanced budget increase in taxes and expenditures will reduce consumption
and investment and raise the real interest rate. A balanced budget decrease
in taxes and expenditures will increase consumption and investment and lower the
real interest rate.
A balanced budget change in expenditures and taxes shifts how output is allocated
to private uses (consumption and investment) and public uses (government purchases).
Think of total output as a pie to be divided among various uses. A balanced
budget change does not alter the total size of the pie; under our assumption that
the economy remains at full employment, output remains at its full-employment
level. Its effect is simply to change how the pie is divided. If government expenditures
and taxes increase, private-sector spending on consumption and investment
shrinks—it is crowded out—to make room for increased public-sector spending.
Crowding out occurs even if the government increases taxes enough to fully pay
for the increased expenditures, as individuals adjust to higher taxes in part by
reducing private saving.
In this example, the total pie—full-employment output—was treated as fixed. It
is important to understand why this is the case. In Chapter 24 we learned that fullemployment
output depends on the economy’s capital stock, its technology, and the
level of employment that occurs when demand and supply balance in the labor
market. None of these factors is likely to be affected directly by changes in general
government expenditures or taxes. Thus full-employment output, potential GDP,
will remain unchanged. However, government expenditures can have an impact on
future income levels and growth. For example, increased government purchases
that lower private-sector investment will reduce the amount of capital that the
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