Unit 16. Fiscal Policy

1. Unit 16. Fiscal Policy

2. I. What is fiscal policy? Fiscal policy entails the use of the government’s taxation and expenditures policies in order to achieve macroeconomic goals, such as full employment, rapid economic growth, and stable price level, etc.

3. President George W. Bush nominated John William Snow to be the 73rd Secretary of the Treasury on January 13, 2003. The United States Senate unanimously confirmed Snow to the position on January 30, 2003 and he was sworn into office on February 3, 2003 . As Secretary of the Treasury, Snow works closely with President Bush on a broad array of economy policy issues. John W. SnowSecretary of the Treasury Before coming to Treasury, Snow was Chairman and Chief Executive Officer of CSX Corporation, where he successfully guided the global transportation company through a period of tremendous change. During Snow’s twenty years at CSX, he led the Corporation to refocus on its core railroad business, dramatically reduce injuries and train accidents, and improve its financial performance.

4. II. Budget Deficits & Surpluses

5. A. Balanced Budget（预算平衡） Fiscal policy is reflected through the government's spending, taxing and borrowing policies. It is one of the major tools, which might be used to help promote the macroeconomic goals. Government expenditures must be financed with • taxes • borrowing • other revenues generated from the sale of services or assets

6. = government revenues government spending Balanced Budget purchases of goods and services transfer payments taxes sales of services Note: The budget need not to be in balance.

7. If, revenues > expenditures fiscal surpluses If, revenues < expenditures fiscal deficits A budget surplus is present when the government’s revenues exceed its total expenditure. This surplus can be used by the government to reduce its outstanding debt. B. Budget Deficits & surpluses（预算赤字和盈余） When a budget deficit is present, the government must borrow funds to finance the excess of its spending relative to revenue. It borrows by issuing interest-bearing bonds that become part of what we call national debt, the total amount of outstanding(未偿付的）government bonds.

8. C. Influence the Economy by Government’s Budget The government budget is much more than a mere revenue and expenditure statement of a private organization, and it is the primary tool of fiscal policy. The government can alter its budget to influence the future direction of the economy, changes in the size of the federal deficit or surplus are often used to gauge whether fiscal policy is adding additional demand stimulus（需求刺激） or imposing additional demand restraint （需求抑制） to the national economy.

9. When an economy is operating below its potential • capacity, in order to stimulate the economy, according to Keynesianism（凯恩斯主义）, the government should implement expansionary fiscal policy（扩张性财政政策）. In other words, the government should either increase its purchases of goods and services or cut taxes or both, of course, this policy will increase the government’s budget deficit. In order to finance the enlarged budget deficit, the government will have to borrow from either • private domestic sources or foreigners. • When an economy grows so fast that the inflation rises sharply. In order to curb inflation, the government should carry out restrictive fiscal policy. That is to say, the government reduces the purchases of goods and services and/or increase tax rate to collect more taxes to diminish aggregate demand directly and dampen consumption and investment. This leads to the slow-down of the national economy and the reduction of inflation rate.

10. III. Crowding-out Effect（挤出效应）

11. When the government borrows funds to finance an enlarged deficit, typically it will do so by issuing bonds. Issuing bonds is simply a means of demanding loanable funds. The total demand for loanable funds will increase as government borrowing competes with private borrowing for the available supply of funds, which is fixed. Thus, the additional government borrowing to finance an enlarged deficit will increase the demand for loanable funds and raise the interest rate. It is an adverse effect that tends to weaken the potency of fiscal policy. A. What is crowding-out effect? Private borrowing Government borrowing Interest Rate

12. Consumers will reduce their purchases of interest-sensitive goods, such as autos and housings The rise of the interest rate caused by crowding-out effect of fiscal policy • More importantly, a higher interest rate will increase the borrowing costs of businesses. Businesses will delay to borrow for further investments (such as plant expansions and heavy equipment). B. The Impact of Crowding-out Effect on Economy This reduction in private spending as the result of higher interest rate at least partially offset additional spending emanating from the deficit. So, the crowding-out effect suggests that the impact of a budget deficit on economy may not be very potent. So, it will slow down the overall national economy. In an open economy, the higher interest rate will lead to an inflow of capital, a currency appreciation, and a decline in exports.

13. C. Visual Presentation of the Crowding-Out Effect in An Open Economy: decline in private investment & consumption increase higher in real budget interest deficit rate inflow of appreciation decline in capital from of local net abroad currency exports