How has this trend affected the government’s ability to fund its discretionary spending

Assignment:

1. Figure 12-9 on page 272 displays real investment spending as a percentage of global real GDP since the mid-1990s for developed versus emerging nations. The figure shows that in recent years, decreases in planned investment expenditures as a percentage of global real GDP have occurred in highly developed countries. In contrast, planned investment spending as a percentage of global real GDP has been rising for nations with emerging economies.

Global real GDP has increased every year except for a brief dip during 2009. Consequently, planned real investment has risen in all nations in most years. What Figure 4 depicts, therefore, is a shift toward relatively greater increases in planned investment in emerging nations compared with developed countries.

Within any nation’s economy, variations in planned real investment spending operate through the multiplier to bring about changes in equilibrium real GDP. Thus, a country that experiences a larger upward shift in its planned investment function than another nation will, if both countries’ multipliers have close to the same values, observe a greater increase in its equilibrium real GDP

This relatively larger increase in investment spending helps to explain why countries such as China, India, South Korea, and Singapore are emerging from a status of less developed toward eventual classification among developed nations. Relatively higher planned real investment expenditures in these nations are, through multiplier effects, boosting real GDP per year. Thus, flows of real GDP are expanding faster in these emerging-economy countries than in developed ones.

a. If interest rates, or opportunity costs of investment, happened to be the same in both developed countries and emerging economy nations, what could account for faster upward shifts in the latter group’s planned investment functions?

b. Are stocks of productive capital currently growing at a faster pace in developed countries or in emerging-economy nations? Explain.

Resources

To track real investment spending as a percentage of real GDP in recent years for individual nations, go to Spending vs GDP.

For links to economic data for both developed countries and emerging-economy nations, go to IMF.org.

2. Paying off State Debts instead of Boosting Expenditures

Figure 13-7 on page 292 of your textbook displays two sets of data. One is the cumulative quantity of grants of discretionary funds transmitted from the federal government to state governments since late 2008. The other is the net amount of borrowing by state governments.

As grants of federal funds to state governments accumulated after 2008, the net borrowing of state governments declined. Many state governments were heavily in debt at the end of 2008, with borrowings in excess of $160 billion. For these states, the receipt of discretionary federal grants beginning in 2009 was a godsend, because it allowed them to start paying off a number of existing debts.

Debt Repayments are not Immediate Flows of Spending

The funds intended by the federal government to enter the nation’s flow of income and expenditures did not reach that flow. States sent them to creditors.

Rather than direct the federal funds to additional spending, therefore, the state governments used the bulk of ARRA federal grants to pay off part of debts generated by spending projects completed in prior years. Most estimates indicate that of the federal “stimulus” funds given to state governments, less than 5 percent were directed toward new spending within the nation’s flow of income and expenditures. Thus, a 95 percent direct fiscal offset resulted. Instead of providing an immediate boost in state infrastructure spending on roads, bridges, and the like, nearly all of the federal funds transmitted to state governments for spending instead were saved.

a. Why might federal spending on roads, waterways, or national security be less subject to direct expenditure offsets than spending on health care or education?

b. What might account for the fact that estimates of effect time lags for fiscal policy often differ considerably across different types of government expenditures?

Resources

Take a look at the U.S. government’s official Web site for tracking the use of ARRA funds at U of W – ARRA.

For further discussion of why directing so many federal ARRA funds to the states failed to produce very much fiscal stimulus to the U.S. economy, go to ARRA Fizzle.

3. The U.S. government is in the midst of spending more than $1 billion on seven buildings containing more than 100,000 square feet of space to be used for study of infectious diseases. Prior to the government’s decision to construct these buildings, a few universities had been planning to build essentially the same facilities using privately obtained funds. After construction on the government buildings began, however, the universities dropped their plans. Evaluate whether the government’s $1 billion expenditure is actually likely to push U.S. real GDP above the level it would have reached in the absence of the government’s construction spree.

4. The Share of Tax Revenue Going To Discretionary Spending

Figure 14-6 on page 312 of your textbook shows the share of total federal spending on entitlements has increased during the past 20 years. How has this trend affected the government’s ability to fund its discretionary spending?

Figure 14-7 on page 314 of your textbook displays the percentage of tax revenues available to apply toward discretionary spending—that is, after paying for entitlement expenditures—since the early 1990s. During the late 1990s, this percentage rose above 100 percent, meaning that the federal government officially operated with surpluses and paid down some of its outstanding debts.

After the late 1990s, however, the percentage of tax revenues available to cover discretionary spending after paying entitlements steadily declined. Since the late 2000s, this percentage has dropped substantially.

Indeed, during periods in which the percentage of tax revenues available to allocate to discretionary spending has been zero or negative, the federal government’s tax revenues have been insufficient to pay for any of its discretionary spending. During these intervals, all discretionary spending has been financed with borrowed funds.

Borrowing in Part to Cover Entitlement Spending

When the share of federal tax revenues allocated to discretionary spending is below zero, the government borrows more than the amount of its discretionary spending. During these intervals, the government borrows funds to help pay some of its non-controllable expenditures on entitlements as well as to cover its discretionary spending.

a. What would be true of entitlement spending if the percentage of taxes allocated to discretionary spending rose to 100 percent and the federal budget was balanced? (Hint: Under a balanced budget, tax revenues equal the sum of discretionary and non discretionary expenditures.)

b. How would entitlement spending be funded if tax revenues just covered discretionary spending and there was a government budget deficit?

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