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Chapter 27: Problem 8

In January 2017, the Congressional Budget Office (CBO) noted that its "estimate of the deficit for 2017 has decreased since August 2016." The CBO also noted that its "economic forecast ... underlies its budget projections." a. Why would the CBO's forecast of future levels of GDP and employment matter for its forecasts of future federal budget deficits? b. If the federal budget deficit turns out to be smaller than expected, it is likely that economic growth was higher or lower than expected? Briefly explain.

Short Answer

Expert verified
The forecast of future levels of GDP and employment significantly affect the federal budget deficit forecasts because they directly impact government revenues. A higher GDP and employment level mean more tax revenues, which can help decrease the deficit. If the federal budget deficit is smaller than expected, it's likely that economic growth was higher than anticipated.

Step by step solution

01

Why GDP and Employment Matter

These two factors are important because the level of GDP and employment has a major impact on the government's revenues. The higher the GDP and level of employment, the more people there are earning income and the more corporate profits are being generated - both of which increase tax revenue.
02

Understanding Budget Deficit

A budget deficit occurs when expenditures exceed revenue. If GDP and employment are high, this increases revenue through taxes, which can help reduce the deficit. Conversely, if these two indicators are low, revenues may decrease, leading to a larger deficit.
03

Relationship Between Deficit And Economic Growth

If the deficit is smaller than expected, it indicates that either the government's revenues were higher or its expenditures were lower than projected. Higher revenues could result from more robust economic growth, meaning that GDP growth was likely higher than expected.
04

Recap of the Economic Cycle

So, in essence, higher GDP and employment levels lead to increased tax revenues, which reduces budget deficits. Meanwhile, a smaller budget deficit is likely a sign of higher-than-expected economic growth.

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Most popular questions from this chapter

Wall Street Journal writers Josh Zumbrun and Nick Timiraos published answers to several of their readers' questions regarding the federal government's debt. The following were two of the questions. Write a brief response to each question. a. Why is government debt different from mine? b. How important is it to pay off this debt?

If Congress and the president decide that an expansionary fiscal policy is necessary, what changes should they make in government spending or taxes? What changes should they make if they decide that a contractionary fiscal policy is necessary?

(Related to the Apply the Concept on page 978 ) In 2017 , an article in the New York Times quoted Douglas HoltzEakin, former director of the Congressional Budget Office, as arguing that "with the economy back to near full employment, conventional tax cuts or stimulus spending won't have that much of an effect. What is needed are policies that genuinely augment the supply side of the economy." a. If the economy is at full employment, what economic variables will conventional tax cuts or stimulus spending not affect much? What variables might these policies affect? b. What does Holtz-Eakin mean by "policies that genuinely augment the supply side of the economy"?

(Related to the Apply the Concept on page 969) The following is from a message by President Herbert Hoover to Congress, dated May 5,1932: I need not recount that the revenues of the Government as estimated for the next fiscal year show a decrease of about \(\$ 1,700,000,000\) below the fiscal year \(1929,\) and inexorably require a broader basis of taxation and a drastic reduction of expenditures in order to balance the Budget. Nothing is more necessary at this time than balancing the Budget. Do you think President Hoover was correct in saying that, in \(1932,\) nothing was more necessary than balancing the federal government's budget? Briefly explain.

In what ways does the federal budget serve as an automatic stabilizer for the economy?
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