Fiscal policy clap back: understanding the economic role of the federal government

Course: Principles of Macroeconomics

Prior knowledge: Students will have some understanding of the types of fiscal policy (discretionary and automatic), the tools of fiscal policy (spending and taxation), as well as knowledge of federal budget basics: receipts, outlays (mandatory v discretionary), deficits, surplus. Students should have reviewed the most recent full fiscal year CBO Federal Budget Review. They should also know some history of the federal budget, namely that deficits have been the norm over the past 50-60 years.

Class size limitations: no

Time needed: 25 minutes: 5 minutes for students to discuss and decide 15-20 to debrief

Overview

It is important for well-informed citizens to understand the role of the federal government in the US economy. The federal budget deficit and national debt are often mischaracterized and misunderstood. In this activity, students will use their knowledge of fiscal policy and the federal budget to decide whether or not the federal budget should be balanced on an annual basis.

Expected Student Learning Outcomes

Students will be able to evaluate the potential of the federal budget to stabilize economic activity.

Information Given to Students

Suppose you saw a TikTok of (insert Senator or House member who has made an assertion like this) advocating a requirement that Congress always balance the federal budget and would like to respond. Which argument should you use in your video response?

A. It is important to live within your means. Households have to balance their own budgets so we should expect the same thing from our federal government.

B. It has been over 20 years since the federal government has had a budget surplus and budget deficits are definitely the "norm." We need to change our ways. Plus, if the national debt gets too large, it could lead to higher borrowing costs for the federal government (would have to offer higher interest rates to entice people to buy its bonds)

C. Suppose there is a recession which automatically leads to reduced federal tax revenue and increased spending on safety net programs. The only way to balance a budget during a recession would be to cut spending or increase taxes, thereby worsening the recession.

D. Congress only controls about one third of annual federal spending (discretionary spending) and the rest is automatic so Congress probably could not balance the budget without changing laws about Social Security, etc.

Prefatory: remind students of the types of fiscal policy (discretionary v. automatic) and that some federal outlays are controlled by Congress (discretionary spending) and others over which Congress has no control (mandatory). It would also be helpful to have reviewed the CBO Federal Budget Review document together as a class noting the major sources of both federal receipts and outlays.

Follow up questions:

1. In what ways is the federal government like a household? How is the federal government different from a household?

2. What happens if the US has to offer higher interest rates to entice people to buy bonds and lend it money? What is the opportunity cost? What is the current interest rate on a 30 year Treasury bond? (should be easy to look up)

3. During the early days of Covid 23 million people lost their jobs in a month. What happened automatically to federal receipts? Outlays? The federal budget? If Congress is required to *always* have a balanced budget, what would they have had to do during Covid?

4. What kind of laws would Congress have to change to be able to balance the budget? What would likely have to happen to Social Security and other mandatory programs? What is the political likelihood of this happening?