Archive for October, 2012

Oct 30 2012

Visualizing recession’s effect on government deficits and debt

Fiscal policy consists of the use of taxes and government spending in the economy to promote macroeconomic objectives such as full employment, economic growth, low inflation and reduced income inequality. When an economy is doing poorly, the government’s fiscal policies tend to result in large budget deficits, which occur when the amount of expenditures exceed the amount of tax revenue collected in a particular year.

When a government runs deficits year after year, each deficit is added to the nation’s debt. The charts below, created using Google’s Public Data Explorer, provide a snapshot of the deficit and debt situations experienced by the countries of Europe over the last couple of decades. Study the graphs closely with your class, then read the analysis and explanations that follow!

Automatic stabilizers in Fiscal Policy

When an economy is doing well, fiscal policy adjusts automatically to bring down deficits, and even allow a government to run a budget surplus if the tax revenues exceed government expenditures. When the economy slows down, output falls, and unemployment rises, government spending and taxation automatically adjust in ways that move the budget towards deficit, in which the government spends more than it collects in taxes.

These automatic adjustments to fiscal policy result from the effect growth or recession have on previously mandated government expenditures and tax receipts. For example, imagine the US economy slips into a recession:

  • As demand for the nation’s output falls, the incomes of producers and workers decline, therefore the amount of income tax received by the government decreases automatically
  • At the same time, more workers are becoming unemployed, making them eligible to receive unemployment benefits from the government. More people slip into poverty and begin to receive welfare and government health insurance, and perhaps even subsidized housing and food.
  • Revenues automatically decline while government spending automatically increases, moving the budget further into deficit.

Next imagine the US economy has recovered and is growing at rates above its long run average growth rate. During such “booms” in the business cycle, the following occurs:

  • Business and household incomes are rising, so more income tax is being paid, increasing government tax revenues.
  • Unemployment is falling, meaning fewer people receive government benefits. Fewer people are in poverty, meaning less spending on transfer payments that support the poor.
  • With tax revenues increasing and government transfer payments decreasing, the budget automatically moves towards surplus.

These “automatic stabilizers” should mean that as an economy experiences the normal fluctuations of its business cycle, the government budget fluctuates between surpluses and deficits, and over time, national debt is kept nice and low. But as we saw in the graphs linked in the top of this post, a sustained downturn in economic activity can lead to structural deficits that persist for years and years. Persistent budget deficits mean an ever ballooning national debt, as can be seen in this chart:

As the graph above shows, over time, large deficits lead to ever growing debts. Notice the general inverse relationship between the size of a country’s budget deficit and the size of its national debt. Countries in the upper left hand corner of the graph generally have low deficits (or budget surpluses) and enjoy relatively small national debts. In the lower right, on the other hand, large deficits have lead to levels of debt frighteningly large as a percentage of the countries’ GDPs.

Discretionary Fiscal Policy

What does all this mean for government policy makers? Let’s first distinguish between the automatic fiscal policy described above and discretionary fiscal policy. Much of the increase in budget deficits and national debts seen in the charts in this post can be explained by European governments’ initial responses to the economic downturns first seen in 2007 and 2008. When unemployment began to rise and output began to fall across Europe, the first response of many governments was to intervene to try to stimulate aggregate demand  beyond what was provided automatically through increased transfer payments and decreasing tax receipts. Discretionary fiscal policy refers to deliberate changes to overall tax rates and government spending aimed at directly or indirectly stimulating (or contracting) demand in the economy to help move an economy back to its full employment level during a recession (or, in some cases, during a period of high inflation).

Discretionary fiscal policy, when used during a recession, will drastically increase the size of a budget deficit (and therefore, the national debt). Why do it, you ask? Advocates of such policies (often known as Keynesians, after John Maynard Keynes, whose theories formed the basis for such policies) argue that a recession must be reversed as soon as possible, or else the burden of a nation’s existing debt will grow (as a percentage of its GDP) as the country’s GDP falls. More importantly, of course, is the human and social cost of a recession, as workers become unemployed and hardship spreads among the nation’s households.

A short-term increase in the budget deficit may pay for itself if the subsequent increase in overall demand is mulitplied throughout the economy and overall GDP increases by more than it would have with only automatic stabilizers to rely on. Government spending on infrastructure, education, health, and other public goods creates jobs, increases household income, provides the economy with new capital and infrastructure, increasing the nation’s production possibilities and boosting demand to move the economy closer to full employment. Higher incomes among those employed in government projects will be spent, creating even more new jobs in the private sector.

Discretionary fiscal policy aimed at stimulating demand requires a government borrows money, increasing the national debt. But if such policies are successful, the debt burden will be smaller over time since economic growth may return, increasing the GDP and thus allowing the budget to move back towards surplus sooner, as automatic stabilizers once again kick in.

Evaluating the use of Fiscal Policy for managing the economy

Understanding the difference between automatic and discretionary fiscal policy, and the impact that expansionary policies have on budget deficits and national debt, provide us with tools for evaluating its use during recessions or periods of high inflation. However, we need to know more about the impact of deficits and debt in order to fully evaluate its use. For that, you’ve got to read some more posts and watch some videos. Here are some key resources that will help you evaluate the use of fiscal policy for fighting recessions.

After watching these two video lectures and reading the post, answer the discussion questions that follow:

  1. Explain the huge increases in national debts (both in Euros and as percentages of the countries GDPs) during the later part of the decade from 2000 to 2010.
  2. How does automatic fiscal policy differ from discretionary fiscal policy?
  3. How does the multiplier effect of fiscal policy provide support to the Keynesians’ views that tax cuts and increases in government spending can highly effective at getting and economy out of recession?
  4. How does the crowding-out effect of fiscal policy support the opponents of its use who argue that government spending and tax cuts will only make an economy less competitive and grow more slowly in the long-run?

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Oct 23 2012

Income Inequality’s Effects on Social and Economic Well-being

Inequality exists everywhere we look. Whether you live in a rich country or a poor one, there is inequality both within and between societies. Even a rich country like Switzerland has vast gaps between its richest and poorest households; and while there is no absolute poverty in rich countries like Switzerland, relative poverty exists as some within society earn an income and enjoy a standard of living significantly below those of others.

Is inequality a problem worth worrying about, however? There are arguments for and against making the reduction of income inequality a priority for government policy makers. To reduce inequality, argue some, the rich must be forced to give up some of their wealth in order to provide for the poor. Such ‘redistribution’ reduces incentives to work hard and therefore reduces the efficiency and productivity of society as a whole. ‘Handouts’ to the poor reduce their motivation to work, since more work and higher incomes would mean fewer government benefits and higher taxes.

Such a view is widely held among members of the Republican Party in the United States, including presidential candidate Mitt Romney, whose now infamous ‘47%’ comments reveal his lack of concern over the existence of inequality within the United States.

Romney’s 47% comments are in reference to Americans who, due to the progressive nature of America’s tax system, do not pay federal income taxes. (USA Today produced a very informative interactive graph providing a closer look at the 47%, which can be viewed here. Interestingly, of Romey’s 47%, 28% did pay federal payroll taxes which are non-progressive. Only 6.9% are the ‘working poor’ whose incomes are so low they pay no federal tax at all. The other 10% are elderly Americans who are no longer earning incomes and thus pay no income taxes).

The purpose of a progressive income tax scheme such as America’s is to place a larger burden of the total tax collections on the richest households, those who can most afford to pay taxes. When higher income earners pay a higher percentage of their income in taxes, and lower income earners pay lower tax rates, the after tax incomes earned by households will be more equal, and government is provided with a pool of tax revenues overwhelmingly paid by the rich. A large proportion of government programs intended to help the middle and lower income earners are then funded by the rich, effectively reducing the level of income inequality in society.

All forms of government spending are, essentially, forms of redistribution. Military spending redistributes income from households to defense, agricultural subsidies redistribute income from everyone to farmers and agro-businesses, spending on primary education redistributes income from all households to just those families with young children, the paving of roads redistributes income to people with cars, and so on… Fiscal policy itself is the act of collecting and redistributing income between different groups of households and firms. The extent to which fiscal policy can reduce income inequality, or SHOULD try to reduce income inequality, is the topic of much debate.

Recent studies have found that the existence of high levels of income inequality may be correlated with low levels of achievement in many social, human health, and economic indicators of well-being. Notably, the research undertaken by Richard Wilkinson, of the University of Nottingham, sheds a light on the effect that inequality has on society. Watch the TED talk below in which Wilkinson shares his research.

Inequality’s effects on social well-being

Using publicly available data, Google’s Public Data Directory allows us to create interactive graphs demonstrating the correlation between the level of inequality in nations and other social and economic indicators. The links below will take you to different charts I created while exploring the available data. Study each of the graphs and discuss with your class the relationship illustrated and possible explanations for the relationship.

Next, use Google’s software to create your own graphs exploring the relationship between income inequality (as measured by the Gini Index) and other economic or social indicators of well-being. Were you able to observe other correlations between inequality and social or economic welfare?

More reading on inequality

Last week’s Economist featured a special report on inequality, For richer, for poorerIt provides a great overview of the issue of inequality around the world, but focuses on inequality within countries, the threats it poses and the possible solutions to reducing it without undermining efficiency and economic growth.

I have selected the three most important articles from this report, which my students can access and read here.

Discussion Questions in Inequality

  1.  Identify two methods used for measuring income inequality (one used in Wilkinson’s talk and one is used in the Google Public Data Explorer). How are these two methods similar? How are they different? What are their short-comings?
  2. How have changes to nation’s economies brought about by globalization helped simultaneously reduce inequality between nations while increased inequality within nations?
  3. The existence of high levels of income inequality actually contributes to the efficiency with which an economy functions. Provide one argument for this claim and one argument against it.
  4. A highly progressive income tax system in the United States has somehow failed to reduce income inequality, which has actually grown. Besides a progressive tax system, what other elements must a nation’s fiscal policy include to promote greater equality? (Refer to the section from the Economist’s report on Sweden in your answer).

2 responses so far

Oct 12 2012

Google Apps for Educators Workshop – Using Google forms to gather and analyze data from your students

Published by under Teaching

Part 1 – Demonstration:

As a teacher of a subject in which data forms the basis all understanding, I like to put my students to work finding and analyzing the data most relevant to our subject. In my unit on Macroeconomics (the study of entire nations’ economies), I teach that the primary objectives of government and central bank policies is to achieve four goals. These are:

  • Price level stability (low inflation)
  • Economic growth (increase in income over time)
  • Low unemployment
  • Relative equality in the distribution of income
Each of these objectives can be measured using data recorded by every nation in the world which are, fortunately for me, made public through many online databases. The one I find most useful is the CIA World Factbook, which publishes economic data for all countries for which it is available. The link below will take you to the CIA World Factbook, where you can find economic data for your own country.
The CIA World Factbook
One of my favorite lessons at the beginning of my Macroeconomics unit is to have students find their own countries on the CIA World Factbook and enter the data relating to the four macroeconomic objectives into a Google Form. To demonstrate how this works, follow the link to the CIA World Factbook above, find your own home country, click on the “Economy” section and find and enter the data requested in the form below:
Macroeconomic Indicators Around the World – Google Apps for Educators Sample Form
The cool thing about Google Forms is that the creator of the form has total control over the results as they are submitted by students. For example, as you and the other attendees of this workshop are submitting your results, I am examining the results in real time. Every time the ‘submit’ button is pressed, a spreadsheet of all the form results is updated in real time right in front of my eyes. Now, I can begin to organize the results of this data into interactive charts which we can then analyze as a class. For instance, here are some  charts showing the results from the submissions by students in my year 2 IB Economics course this earlier this semester:

Now, as a class, we can gain a deeper understanding of some of the most important macroeconomic indicators using current data from our own countries, researched and aggregated using Google Forms, analyzed using Google Spreadsheets and the charts it can be used to create.

Part 2 – Brainstorming

As an Economics teacher, there are loads of data relating to nearly every topic I teach available online for students to research, aggregate and analyze. But what about in your subject? The second part of this presentation requires you and some of your peers here today to get together and brainstorm how Google Forms and Spreadsheets could be harnessed in your own subject area. Please get together with two or three people around you and discuss the following questions.

  1. What do you teach or what is your role in your educational community?
  2. What role does data play in your field?
  3. How could you harness Google Forms and Spreadsheets to more efficiently and effectively collect and analyze data either for educational or productivity enhancing purposes?

Take 10 minutes and discuss these questions with the people around you. Once you’ve discussed the questions, follow the link below and share your your thoughts on how you could use Google Forms in your role as a member of a faculty or staff in an educational community.

Brainstorming Form – How can I use Google Forms to enhance data collection and analysis in my classroom or workplace?

At the end of this session, the results from everyone’s brainstorming session can be viewed publicly by clicking here: Google Forms for Data Analysis – Brainstorming Results

If you have any questions about how I use Google Forms or other Google Apps in the classroom, please send me an email at welkerswikinomics@gmail.com. I hope you enjoyed today’s presentation, and thanks for coming!

One response so far

Oct 08 2012

Is Switzerland becoming a feudal state?

Switzerland “could become a feudal state” claims an economist. – swissinfo

One Zurich economist thinks so:

In Switzerland 71 per cent of the wealth is concentrated in the hands of just ten per cent of the population – a figure that economist Hans Kissling finds alarming.

Kissling tells swissinfo that the gap between the rich and everyone else is growing and that this could threaten traditional Swiss democracy and the economy. He makes a call for an inheritance tax for the wealthy.

Statistics show that the 300 richest people have become 40 per cent wealthier in the past eight years, whereas most of the population has a lower income than at the beginning of the 1990s

Kissling has nothing against wealth, he just thinks that if someone did not earn their wealth but inherited it instead, they should have to share a bit with the rest of society.

I call for a tax on very high inheritances, from SFr1 million ($900.000) upwards, and only on the excess value of that. I certainly don’t want people to think that they can’t pass on their family home to the next generation.

I’m only interested in trying to stop any creeping feudalisation, to avoid having huge clans like in South America, which threaten the economy and the political world

He’s most concerned that if the gap between rich and middle class continues to widen and the middle class of Switzerland don’t start benefiting from the country’s growing wealth, there could be a dangerous backlash against the free market system.

…the richest one tenth of a percent in Zurich – there are no full Swiss statistics – had 677 times more wealth than an average citizen in 1991. By 2003, 12 years later, the richest one tenth of a percent had 1,027 times more wealth. So the gap has really grown.

The middle classes, unlike the lower classes, have not benefited from any concessions, such as health insurance or childcare allowances. Here they have to use up all their assets before they receive any support. The lower classes have help from the beginning. This is why the middle classes are threatened

Discussion Questions:

  1. Why does a growing gap between rich and middle class threaten social stability in Switzerland?
  2. What threats do growing inequality pose to Economic growth?
  3. What are the benefits of an inheritance tax as a means to reduce wealth and income inequality? What are the arguments against such a tax?
  4. What other types of government policies could reduce the wealth and income inequality that exists in Switzerland?

13 responses so far