Wednesday
25 August
0800 - 0930 (IS)
"Blessed are the young, for they shall inherit the national debt."
Herbert Hoover
Overview
Winston Churchill is renowned for having said that democracy is the worst form of government - except for all of the others. On the subject of economics, perhaps the same can be said of market economies. In this section, we will explore some of the difficulties encountered by market economies.
Historically, the two most common economic problems have been inflation and unemployment. Until the American economic boom of the 1990s, it was thought that either inflation or unemployment was inevitable - if you did not have one then you were facing the other. The ideal was to keep them at some acceptable level of balance. Inflation (an overall increase in prices) is the result of an excessive demand on limited supply. As unemployment decreases, the ever-increasing demand for labor (that is, the creation of new jobs), permits workers to "sell" their services at a higher price, eventually causing inflation. Similarly, when prices become too high (due to inflation), the amount of goods and services people can buy declines, resulting in a lower demand for labor (an excess of supply) generating increased unemployment.
In recent years, much attention has been given to the topic of fiscal deficits - that is, when governments spend more money than they take in through revenues (e.g., taxes, fees). Collectively, un-repaid past fiscal deficits comprise the national debt. There is significant debate as to whether government debt is really harmful to the country and future generations. There are convincing arguments that say that a reasonable amount of debt may be acceptable. As you will see, the incurrence of a fiscal deficit can sometimes be considered an appropriate corrective tool when economies suffer periods of crisis.
At the extremes, when market economies experience their worst problems, nations suffer hyperinflation, recessions and depressions. During such times, total output of the economy falls - that is, instead of growing, the economy shrinks. The result has humanitarian as well as political consequences, as many people lose their jobs and homes. In some countries, economic crisis can result in political instability, bringing down governments and increasing the potential for physical conflict, a subject discussed in greater detail in Topic 7.
Objectives
- Develop a perspective of the problems that regularly occur within market economies.
- Understand the nature of inflation and unemployment and how these two concerns are related.
- Understand the causes and nature of economic recessions and depressions.
- Understand the nature of fiscal deficits and their importance in the context of an overall economy.
Issues for consideration
- Explain the relationship between supply, demand, inflation, and unemployment.
- What is your informed opinion about government deficits and debts? How much do these concern you: not at all, a little, a great deal? Why?
- If the United States is able to maintain budget surpluses for the foreseeable future, how do you think these should be used? Should they be "invested" in education or the social security system, used to reduce the national debt, or returned to the people in the form of tax reductions? Why?
- What is your opinion about inequity in income distribution? Should the government intervene to correct this? If so, when should it do so and how?
- What are the key problems facing the U.S. economy, today?
- Do you trust economic forecasts (for example, projections of U.S. Government deficits or surpluses)? Why might they be inaccurate? What is the risk in trusting them? Why are forecasts useful? Who uses forecasts?
Required readings (76 pages)
* Baumol and Blinder: Chapters 23 [Skip pgs. 551-553, "Inflation and the Tax System"] (24 pgs.) and 32 [Skip pgs 757-760, "Budget Deficits and Inflation" and "The Monetization Issue"] (21 pgs.)
* Heilbroner and Thurow: Chapters 13 (12 pgs.) and 15 (9 pgs.)
* "Baby-Sitting the Economy," Paul Krugman, Slate, August 13, 1998 (10 pgs.)
Suggested reading
* "Singing the Deflationary Blues," The Economist, October 13, 1998 (3 pgs.)
* "A Citizen's Guide to the Federal Budget," OMB FY 2000 (30 pgs.)
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