Question

The United States federal government is responsible for meeting the spending obligations of the US government, or its "unpaid bills." Krugman & Wells (2015), explained if taxes are insufficient to cover government spending then the federal government must borrow to cover the difference. These government borrowing are US Treasuries (Chapter 10, Matching Up Savings and Investment Spending). Reuters (2018, February 18) reported, “…tax reform is expected to add as much as $1.5 trillion to the federal debt load, while the budget agreement would increase government spending by almost $300 billion over the next two years.”

Treasury auctions are the way the United States government finances its debt.  The Treasury sells short-, intermediate-, and long-term IOUs, known as bills, notes, and bonds. US Treasuries are subject to the same laws of supply and demand as the Federal Funds money market we discussed last week. The price and interest paid on U.S. government debt is determined by supply and demand.  When there are few bonds and a lot of demand, prices rise and interest rates fall.  When there are a lot of bonds compared to demand, prices fall and interest rates rise.

Barron’s reported recently reported, “The law of supply and demand meant that the glut of new Treasuries temporarily drove down prices and pushed up yields (interest rates).  The 10-year Treasury climbed during the week – brushing 2.95 percent – but ultimately lost half a basis point, ending at 2.87 percent.  (A basis point is a hundredth of a percentage point.)... The higher that interest rates are on Treasuries, the more interest the Treasury must pay." And the higher the excess of the supply of US Treasuries over demand, the more interest rates will rise.

Herbert Hoover, 31st President of the United States said, “There are only three ways to meet the unpaid bills of a nation. The first is taxation. The second is repudiation. The third is inflation.” In light of what we learned in the recent Chapter 13: Fiscal Policy, in contrast with Chapter 15: Monetary Policy, and this week's chapters 16 and 17, think about the recent decisions by those in the US federal government to take on more federal debt by lowering taxes and running a larger US Federal deficit, and the implications these decisions might have on future inflation and interest rates.

Do you think the economy will grow fast enough so that increases in US GDP and US tax revenues on that spending will compensate for the decrease in taxes? Or are you more concerned about rising interest rates threatening the US economic expansion, and a growing US federal debt? Defend your position with economic theory and data. Consider the Phillips Curve. Consider the expected changes in inflation and/or unemployment and who would be impacted by those changes (for example, borrowers, lenders, the unemployed, retirees on pensions, young workers, those nearing retirement). Use current economic data from the Bureau of Labor Statistics, the Census Bureau, the Federal Reserve, etc., and cite your sources.

Answer 1

When the taxes are decreased and the spending is increased leading to a larger deficit, the aggregate demand in the economy falls leading to fall in output and employment if the supply is kept constant. This fall in employment leads to an increase in unemployment and in the short run if the philips relationship hold true, increase in unemployment should lead to fall in expected inflation. The increase in spending might also result in increae in output manifold letting the multiplier process to work and the targetted groups of government spending will improve despite country running fiscal deficit.