Jan 29 2008

Macroeconomy a major focus in Bush’s final State of the Union address

Economy in focus in Bush address – Jan. 28, 2008

A week into our unit on macroeconomics, we’ve already introduced why the study of macroeconomics is so important. The health of a nation’s economy is dependent on the achievement through macroeconomic policy of three major goals:

  1. full-employment
  2. price level stability, and
  3. economic growth

The word most heard on the lips of economists and political pundits in the US today is recession, a macroeconomic condition in which all three of the above goals are jeopardized. Defined as “a decline in real output over time”, a recession usually leads to unemployment, negative economic growth, and sometimes inflation (a rise in the overall price level), or in some cases deflation (a fall in the price level).

Recessions are usually a result of a decline in consumer spending, which in the US makes up around 70% of GDP. In other words, out of the four types of expenditures (C, I, G and nX), households’ spending on goods and services produced within the US is the largest component of our nation’s national income. When consumers stop spending for some reason, recession is a likely outcome.

[youtube fua1AF9ttqg]

The problem in the US is that households have curbed their spending of late. This is for a few reasons, but the biggest is the loss of wealth due to the falling prices of American’s homes. One determinant of a particular household’s level of consumption is the household’s level of wealth, including the value of its real assets. Due to a housing bubble over the last few years, in which too many new homes were built and bought by people who couldn’t really afford them, today’s demand for houses has lagged behind supply, driving house prices down. Falling values of real estate cause households to reign in their consumer spending, slowing economic growth and threatening recession.

President Bush, now at the beginning of his final year in office, delivered today his annual State of the Union address to Congress. The first issue he discussed in his speech was, unsurprisingly, the economy. The White House has recently given a “economic stimulus plan” to Congress for approval, proposing a “package” consisting of around $150 billion in tax cuts for American businesses and households.

In the economic headliner of his address, Bush urged Congress to pass what is billed as an economic stimulus plan. The program, which was brokered between House leaders and the administration last week, is now facing resistance in the Senate as lawmakers seek to put their mark on it…

The proposal calls for one-time tax rebates to low- and middle-income households and temporary tax breaks for businesses. It also contains two measures aimed at helping homeowners get or refinance mortgages.

The White House has said the plan would add 500,000 jobs and put $100 billion in tax rebates into the hands of consumers. It would limit rebates primarily to individuals making less than $75,000 and couples making less than $150,000.

Bush’s plan is aimed at “stimulating” consumer spending in the economy. Rather than increasing levels of government spending, which would represent a direct injection into the economy (since “G” is a component of GDP), a tax cut will lead to an indirect increase in aggregate demand, and hopefully overall economic output. Here’s how: Taxes are not a component of GDP, which is the sum of consumption, investment, government spending, and net exports. However, the amount of tax paid by households and firms does determine their level of disposable income (DI), which is the main determinant of consumption.

However, not all disposable income gets spent, as some of it will end up as savings. Depending on American households’ marginal propensity to consume (MPC), and likewise their marginal propensity to save (1-MCP=MPS), the $150 billion tax cut should have an overall impact on spending of a little less that $150 billion, since some of the tax cut will turn into household savings.

Much of it, however, will be spent. It is the boost in spending that the White House is hoping will create half a million jobs by the end of the year. While $150 billion sounds like a lot of money, and indeed it is greater than the entire GDP of several developing countries, it represents barely 1% of America’s total income. Skeptics argue that for any significant boost to spending to result, a much larger stimulus package would be needed.

Discussion questions:

  1. If you were given a thousand dollar “rebate” right now, how much would you spend and how much would you save?
  2. Why does new spending equal new jobs in America?
  3. Do you think a stimulus equal to only 1% can have a large enough impact on the US economy to boost it back towards achieving the three main macroeconomic goals mentioned above?

Update: While watching this video a second time, I noticed a line where Bush promises to be responsible with the tax revenues the government collects from American citizens, promising to put the federal budget on a path towards a surplus by 2012. This means that Bush intends to achieve a balanced budget wherein the revenues collected from taxes equal or exceed the total amount of government spending in a given year. It’s a sign of fiscal responsibility that Bush is aiming to achieve such an outcome within the next four years, but I thought it would be interesting to show the history of US federal budget deficits and surpluses over the last few decades.

source: http://www.uuforum.org/deficit.htm

It should be pointed out that under Bush II the largest federal budget deficits in history were run up, probably due to a combination of tax cuts to the rich and a bloated military budget during the years of the Iraq war. So, while his goal of a balanced budget by 2012 is admirable, let’s not forget that under President Bush the US has gone from a budget surplus of $236 billion to a budget deficit of as much as $413 billion.

True, the last three years has seen shrinking deficits, but even in 2006 the deficit still stood at $260 billion. When one ponders the enormity of America’s national debt, which stands at around $9 trillion (almost 3/4 of our GDP!), the urgency of a balanced federal budget is made clear. Makes you wonder making Bush’s tax cuts permanent is really the right thing to do…

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About the author:  Jason Welker teaches International Baccalaureate and Advanced Placement Economics at Zurich International School in Switzerland. In addition to publishing various online resources for economics students and teachers, Jason developed the online version of the Economics course for the IB and is has authored two Economics textbooks: Pearson Baccalaureate’s Economics for the IB Diploma and REA’s AP Macroeconomics Crash Course. Jason is a native of the Pacific Northwest of the United States, and is a passionate adventurer, who considers himself a skier / mountain biker who teaches Economics in his free time. He and his wife keep a ski chalet in the mountains of Northern Idaho, which now that they live in the Swiss Alps gets far too little use. Read more posts by this author

18 responses so far

18 Responses to “Macroeconomy a major focus in Bush’s final State of the Union address”

  1. ElaineLungon 30 Jan 2008 at 9:29 pm

    1. If I received 1k right now, and assuming I were in the US where there are things I actually want to buy, I'd probably save $800, and spend $200. Blowing the entire $1000 off, while helping boost GDP by consumer consumption, doesn't sound very reasonable to me.

    2. As we all know, economics follows a circular flow diagram. Consumer spending means profits for businesses – more money they can spend on capital, which would include labor. Money spent by consumers goes back into that circular flow and into the hands of businesses, who would then have the means (and incentive?) to hire more people. Yayyy.

    3. Full-employment? Price level stability? Economic growth? With a measly $150 billion? Obviously I'm not a real economist, because I seem to be missing something. This less-than-1%-of-total-income is going back into the circular flow diagram, and will be, to some extent helping us move towards those three goals… but I have serious doubts that they will do that much.

  2. Mrs.Brazill, Irondeqon 31 Jan 2008 at 8:59 am

    My students and I also discussed this "stimulus" package. It is important to also note that the expansionary monetary policy enacted by the FED means that there is no pressure now on interest rates, for the short term. My concern is that much of the current account trade deficit is balanced by the surplus in the capital account. What will happen if there is less demand for the interest bearing securities of the United States? President Bush will leave the next president a huge federal budget deficit and an economy that might be just recovering from a recession. What do students think the government should do?

  3. Jason Welkeron 31 Jan 2008 at 10:45 am

    Great point, Mrs. Brazil (who by the way was one of MY econ teachers!). Before I even read your comment, actually, I was inspired by Bush's promise of a balanced budget by 2012 to go find the table I have inserted above showing the budget surpluses and deficits over the last four decades. Interesting to see the the fate of our budget under Bush, isn't it. Are tax cuts and low interest rates a good way to achieve a more balanced budget? As you point out, it's not likely… Looks like the burden of our monstrous national debt is going to be left for the next generation to deal with!

  4. robertwangon 31 Jan 2008 at 7:37 pm

    1. If I received 1000 right now, I'd probably buy a snowboard and then save the rest. =) One, for the occasion right now, it's snowing, that's gotta be a sign, and two, I really want one.

    2. Demand is determined by the amount of people that are willing to and able to pay for a certain good or service. Once consumers are able to spend more, that increases the demand. If more people start to buy certain goods, the producers will need to allocate more resources, creating new jobs.

    3. Like Elaine, I think the 1% will have some effect, but to actually propel the American economy closer to those goals, I think more must be done… Or at least give it more time.

    The graph of America's debt is quite interesting (really strengthen's Clinton's presidency too, hehe). I suppose if Bush had another term, the current trend would bring him back above the o line, but you never know.

  5. Rebecca Sungon 31 Jan 2008 at 9:17 pm

    1. If I'd recieve 1000 USD, I would probably spend about $100 and put the $900 in the bank.

    2. By giving consumers rebate, it is increasing their spending power meaning that they are able to buy more of certain goods and services. As Elaine and Rob already said, this increases demand causing producers needing to allocate more resources; thus, the need to hire more people.

    3. $150 billion seems like a lot of money, but looking at it percentage wise, it is only equal to only 1% of America's total income. Even though it might have some effects, I doubt there would be any significant push of the economy towards its goals with this new "economic stimulus plan."

  6. Hansen Guon 31 Jan 2008 at 9:43 pm

    I'm sure all of us would take the $1000 and use a small portion of it, leaving the rest to interest rates and the bank. However, most of the people receiving this package are not on the same financial level as us. People need this money and can use it to pay off debts, boost some necessities, and just improve their standard of living over all. $600 may not seem like a lot, nor does the package constituting only 1% of the economy. But, will it help? I believe so. Every little bit does and not only does the package come with monetary intentions, with more money I see higher consumer confidence in the government and perhaps in the economy. While again, the number seems small, it's a start.

  7. kevin maon 31 Jan 2008 at 11:09 pm

    1. I wouldn't spend any of the money i received because if America's economy is in recession i would want to save as much money as possible.

    2. Because if more people spend money, businesses will need to produce more of a good. In order for a business to produce more of good, it may have to hire more employees.

    3. Even though 1% seems like a lot of money, I don't beleive it will affect the economy that much. More people will be saving than spending. Many Americans would be paying back debt to like the housing market, which is one of the main causes of America's recession.

  8. Mike Fladlienon 01 Feb 2008 at 12:04 pm

    i believe the Fed should do its job and fiscal policy shouldn't be used…

  9. Steven Lauridsenon 02 Feb 2008 at 3:59 am

    Isn't M. Friedman's permanent income hypothesis relevant here? Half my life ago I remember that being a very big topic in my very first semester of intro to econ, but I never hear about it in debates like this one. I believe it theorized that consumption is a function of 'permanent' income and that a one-time rebate

    (even if it is called a 'bonus'–see the interesting column at http://www.nytimes.com/2008/01/31/opinion/31epley… will be almost entirely saved.

    It sounds to me as though much of the anecdotal evidence backs up Mr. Friedman's now-overlooked idea. Or is it overlooked by you other teachers and students?

  10. yunqimokon 02 Feb 2008 at 5:32 pm

    1. If i received a $1000 rebate, I'd stick it in a European bank and just wait for the Euro to keep soaring.

    2. New spending of course, means greater demand. Since the labor market is "derived demand," the more goods consumers want, the greater demand for labor to produce those goods.

    3. The 1% will surely help, but not bring the economy, who needs at least a 5% boost, get back on track with full-employment, price stability, and a proper inflation rate. Nevertheless, GDP is afterall measured through consumer spending, so if people trust the government and DO spend their rebates, then perhaps the economy will be slightly better off.

  11. KatherineYangon 02 Feb 2008 at 5:44 pm

    1. I would double it by gambling! Just kidding. I'd probably spend a little and save most of it for other really expensive things that take a while to save up to. But I agree with Hanson's point that there are people who would really need to improve their living standards.

    2. New spending means a higher demand for goods and services. Higher demand for goods and services means more resources are needed to produce those goods and services, which means more jobs.

    3. 1% is a little low to really be of help to the economy, but it is a start. Maybe if people start feeling like they can spend more, they will.

  12. kevinhuangon 02 Feb 2008 at 6:38 pm

    1. I would probably save it all in euros because the euros couldn't possibly go down. They have also made lots of progress lately.

    2. As more consumers purchase products from companies that produce these there will be shift in demand to the right and because of the derived demand curve for labor, there will be job opportunities for people.

    3. I don't think it will help since the upper class will invest it, which won't increase jobs. The people who are near the poverty line who receive this tax rebate will only be able to pay back debts that they owe with that money. The middle class will have a mix of these two while only some of them will spend money the money on products.1% of the population is already a very doubtful figure, but considering all these facts, probably around 20% of the 1% of people who get these tax rebates will actually spend money on services and products.

  13. Conrad Liuon 08 Feb 2008 at 1:02 pm

    1. Hmm…1000 dollars? Maybe buy a laptop for once, and save for a total of $200.

    2. With more money, consumers will naturally spend more goods. This causes the demand for these goods to shift to the right. Such an increase will lead to more job openings, in order to accomodate the demands of consumers.

    3. Although 1% of the economy is a small percentage (obviously), it at least signals the beginning of careful economic considerations, and so later on–perhaps not in the next few months or so–but at least in the future, the stimulus will equal a higher percentage.

  14. judychenon 12 Feb 2008 at 2:26 am

    1. I would convert it to RMB and save it bank.

    2. New spending equal new jobs because if there's more spending, that means demand increases, therefore, the demand for labor would increase to produces goods as well.

    3. 1% is a help to US economy but it's not enough to decrease unemployment, stablize price level and encourage economic growth.

  15. Dana Y.on 12 Feb 2008 at 1:19 pm

    1. If I were given a thousand dollar "rebate" right now, I would happily spend some of the money to buy new earphones and save the rest in a European bank.

    2. New spending equals new jobs in America as increase in money will inevitably lead to greater spending, and thus to greater demand.If one applies this concept to the circular flow diagram, it will be easy to see that increased demand would lead to increased supply, which would need more people to produce it (thus raising employment).

    3. It is clear that this stimulus plan will have a positive impact on the U.S. economy: otherwise the Congress would not have passed it. However, the size of impact is questionable. Even though it won't be large enough to "boost it back towards achieving the three main macroeconomic goals," as full employment is in my opinion, only possible in a utopian society, it will make a dent in a positive direction.

  16. serenatuon 13 Feb 2008 at 5:10 pm

    1.If i received 1000 dollars now, i would most likely to spend around 200-300 and save the rest. Depends on whether if there's anything i really want or not.

    2. When people are spending more, that mean the demand for something is increasing, and thus lead the producers to want to produce more of that certain goods or services; more resources such as labors will be needed, therefore creating more job opportunities.

    3. Although 1% of all the Americans income sounds a lot, it might only do a little affect. The economy needs more than that to actually help everyone.

  17. julie.linon 17 Feb 2008 at 10:18 pm

    1. i think i would probably spend around half and save the other half

    2. more demand for goods and services leads to more production, leads to needing more labour.

    3. 1% really isnt a lot and is difficult to have an effect on unemployment

  18. mellissaapyc.wordpress.comon 27 Aug 2016 at 6:29 pm


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