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12.1: Government and the Economy

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  • Learning Objectives

    1. Understand the major components of U.S. government spending and sources of government revenues.
    2. Define the terms budget surplus, budget deficit, balanced budget, and national debt, and discuss their trends over time in the United States.

    We begin our analysis of fiscal policy with an examination of government purchases, transfer payments, and taxes in the U.S. economy.

    Government Purchases

    The government-purchases component of aggregate demand includes all purchases by government agencies of goods and services produced by firms, as well as direct production by government agencies themselves. When the federal government buys staples and staplers, the transaction is part of government purchases. The production of educational and research services by public colleges and universities is also counted in the government-purchases component of GDP.

    While government spending has grown over time, government purchases as a share of GDP declined from over 20% until the early 1990s to under 18% in 2001. Since then, though, the percentage of government purchases in GDP began to increase back toward 20% and then beyond. This first occurred as military spending picked up, and then, more recently, it rose even further during the 2007–2009 recession.

    Figure 12.1 “Federal, State, and Local Purchases Relative to GDP, 1960–2011” shows federal as well as state and local government purchases as a percentage of GDP from 1960 to 2011. Notice the changes that have occurred over this period. In 1960, the federal government accounted for the majority share of total purchases. Since then, however, federal purchases have fallen by almost half relative to GDP, while state and local purchases relative to GDP have risen.

    Figure 12.1 Federal, State, and Local Purchases Relative to GDP, 1960–2011


    Government purchases were generally above 20% of GDP from 1960 until the early 1990s and then below 20% of GDP until the 2007-2009 recession. The share of government purchases in GDP began rising in the 21st century.

    Source: Bureau of Economic Analysis, NIPA Table 1.1 and 3.1 (revised February 29, 2012).