Economic Definition of full-employment budget.

Definition:
A hypothetical federal budget that would exist if the economy were at full employment.
Differences between the actual federal budget and the full-employment budget result from taxes
and expenditures that depend on gross domestic product. The full-employment budget indicates
whether any of the federal government's fiscal policy is over- or under-stimulating the economy
given the current position in the business cycle. During a recession the federal deficit should be
just enough to generate a balanced budget at full employment. The same result is desirable if
we're running a surplus with inflation. If the full-employment budget is NOT balanced, however,
then we're doing too much or too little by way of fiscal policy and changes are in order.

Full-Employment Budget Deficit

Full-employment budget deficits occur when the national economy is at full employment,
yet the federal budget is still operating at a deficit. Full employment does not mean an
unemployment rate of 0 percent, it just means that the employment-to-output level is optimal or
in equilibrium. A budget deficit occurs when the government is spending more money than it is
bringing in.

Understanding Full Employment

 Full employment has two parts, employment and economic output. At
full employment, the unemployment rate is low, around 5 percent. The economic output of the
country, meaning the number of goods produced and services provided in the country, must be at
least 85 percent for the government to consider the country at full employment. This means that
the country is producing goods and providing services at its maximum capacity.

Full-Employment Budget Forecasting

 The main sources of government revenue are individual income, payroll, corporate and
excise taxes. During full employment, more people and businesses are paying these taxes, so
government revenues are increasing and the economy is generally stable or growing.
Government budgetmakers forecast future economic growth on the current economic conditions.
During a time of full employment and economic growth, the government budgetmakers will
assume that revenues will continue to grow. It is on this forecast revenue growth that
budgetmakers will base future government spending. When the actual revenues fall short of
expected or forecast revenues during full employment, it creates a full-employment budget
deficit.
 Full-Employment Deficit Causes
 The main reason why the government would experience a full-employment budget deficit
is simply that the economy fell short of performing as forecast by government budgetmakers and
revenues were less than what they expected them to be. Basically, the government spent more
money during the year than it expected to earn, even though the economy was operating at full
capacity and full employment. As a result, the government will have to borrow additional funds
that it didn't expect to borrow to cover the unexpected budget deficit.

Full-Employment Deficit Cures

 One way to cure or at least alleviate full-employment budget deficit is to increase both
individual income and corporate business taxes. An increase in taxes equals an increase in
government revenue. Since during full employment the economic output is considered to be at its
capacity, the creation of new jobs may not be a viable cure to the deficit. Decreasing government
spending is also a way to alleviate or cure a full-employment budget deficit.

Difference between Full-Employment Budget Surplus and Budget Surplus

a. Budget Surplus:
Budget Surplus (BS) is the excess of the Government’s revenue (taxes) over its total expenditure,
which consists of purchase of goods and services and transfer payments.

... BS is a function of level of income, for a given, government expenditure, transfer payments
and income tax.
b. Effect of Fiscal policy, that is, ∆G and ∆TA on the Budget Surplus:
(i) If Government purchases increase:
BS will be reduce. This is because, due to increase in Government purchases by ∆G, income will
increase. This increase in income ∆Y = α G . ∆G Since, a fraction of this increase in income is
collected in the form of taxes, therefore, tax revenue will increase by tαG . ∆G.
(ii) When tax rate increases

This will lead to increase in the BS

Thus, increase in taxes with government expenditure constant will not lead to decrease in BS

(iii) When ∆G = ∆TA (Balanced budget multiplier)

BS will be unchanged.

Full-Employment Budget Surplus (Bs*):

Cyclically adjusted surplus (or deficit)/

high-employment surplus/

standardized budget surplus/

structural surplus.

It is the BS at full-employment level of income. The full-employment budget surplus (BS*)

shows the budget-surplus (BS) at the full-employment level of income (Y*)

Limitation of Budget Surplus:

If budget surplus is used to measure the effects of Fiscal Policy, then the BS can change if there
is a change in the Autonomous private spending.

According to Dornbusch and Fischer:

1. Full-employment level means an unemployment rate of about 5 to 5.5%. This rate will differ
depending on the assumptions made about the economy at full employment.

2. High-employment surplus is not a perfect measure of fiscal policy because fiscal policy
involves a number of variables like the tax rate, transfers and Government purchases.