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Fiscal Policy

Chapter 11 and 15. Fiscal Policy. Fiscal Policy. The use of government taxes and spending to manipulate the economy. Types of Fiscal Policies. Discretionary Fiscal Policy Non-Discretionary Fiscal Policy. Discretionary Fiscal Policy.

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Fiscal Policy

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  1. Chapter 11 and 15 Fiscal Policy

  2. Fiscal Policy • The use of government taxes and spending to manipulate the economy. Chapter 11

  3. Types of Fiscal Policies • Discretionary Fiscal Policy • Non-Discretionary Fiscal Policy Chapter 11

  4. Discretionary Fiscal Policy • Deliberate manipulation of taxes & government spending to: • Alter GDP • Change employment levels • Control inflation • Stimulate growth Chapter 11

  5. Discretionary Policy Directions • Expansionary fiscal policy • Contractionary fiscal policy Chapter 11

  6. Expansionary Fiscal Policy • Try to increase growth of the economy • During recession Chapter 11

  7. Expansionary Policy Options: • Increase Government spending • Reduce Taxes • Do both Chapter 11

  8. All 3 Expansion Options Lead To: • Higher real GDP • Higher employment • Higher inflation • Higher government budget deficit: • Income same, spending more • Income less, spending the same • Income less, spending more Chapter 11

  9. Contractionary Fiscal Policy • Try to reduce growth of the economy • Use when Cost-Push inflation is high Chapter 11

  10. Contractionary Policy Options: • Decrease Government spending • Increase Taxes • Do both Chapter 11

  11. All 3 Contraction Options Lead To: • Lower real GDP • Lower employment • Lower prices • this is slow because prices are “sticky” • Lower government budget deficit Chapter 11

  12. Individual Deficit Options • If you spend more than you make, you can: • Increase income • Second job, better job • Lower spending • Less fun stuff • Borrow • Bank, friends Chapter 11

  13. Government Deficit Options • If The government spends more than it makes, it has the same options: • Increase income • Raise taxes • Lower Spending • Borrow • Sell bonds • Plus: • Money Creation • Print more money Chapter 11

  14. Government Deficit Impacts • Borrowing • The government is competing with individuals & businesses for the scarce “loanable funds” • When the government borrows, there is less for us to borrow – “CrowdingOut” • Crowding out pushes interest rates higher • Rates are higher, businesses & households are borrowing & investing less. • This is contrary to growth the government is trying to get Chapter 11

  15. Government Deficit Impacts • Money Creation • As they print more money the currency loses value. • Prices are now higher • This makes exporting tougher & importing easier • American products are more expensive • Foreign products are now comparatively cheaper • This costs jobs in the U.S. Chapter 11

  16. Crowding Out • The increased government borrowing lead to higher interest rates. • We are competing with the government to borrow the limited available funds. • The increased government borrowing lead to higher prices. • Deficit borrowing means the government is buying more than it “should”. This increases demand, which increases prices. Chapter 11

  17. Disposing of a Budget Surplus • Debt retirement • Get ahead & pay off bills • Puts $ back in the market, which brings: • lower interest rates • higher investment • higher consumption • higher prices • Impounding • Holding the extra money • Greater contractionary impact Chapter 11

  18. Stimulating the Economy • Which is better at stimulating the economy? • Liberals/Democrats: • expand with increased G • contract with increased taxes • Conservatives/Republicans: • expand with lower taxes • contract with lower G Chapter 11

  19. Non-Discretionary Policies • Built in (Automatic) Stabilizers • Taxes • Unemployment benefits • Welfare benefits • Interest rates • When economy grows, these grow, which slows the economy Chapter 11

  20. Political Problems: • Stability is only one of the economic goals • State & local governments may have balanced budget rules • their actions may go counter to federal actions • Crowding out Chapter 11

  21. Political Problems: • Biases • Tax cuts & increased G are politically good. • Tax increases & cutting G is not • Political business cycle • Offsetting savings • Ricardian Equivalence Chapter 11

  22. Timing Problems: • Recognition lag • Time to recognize the problem • Administrative lag • Time to come up with a plan • Operational lag • Time for the plan to work Chapter 11

  23. Supply Side Fiscal Policy: • Lower taxes leads to higher C • Higher income leads to higher savings • interest rates drop • Lowerinterest leads to more Investment Chapter 11

  24. Supply Side Fiscal Policy: • Higher income leads to more incentive to work more & better • higher productivity • Higher productivity brings higher wages • Lower taxes allows companies more freedom to try new things Chapter 11

  25. The Supply Side Idea: • Output will increase a lot. • Incomes after taxes will increase more than prices will • Taxrevenue from output increase will be greater than revenue lost from cut Chapter 11

  26. Supply Side: AS 1st, then AD New AS AS New AD AD Real GDP New Real GDP Chapter 11

  27. The Supply Side Downside: • The increase in output & benefits of additional Investment takes time. • The increase in efficiency may reduce the number of new workers needed to meet the demand Chapter 11

  28. Keynesian Fiscal Policy • The benefits of tax cuts take too much time • Increase G • AD shifts out immediately • Higher G leads to more income for companies • Higher incomes Chapter 11

  29. Keynesian Fiscal Policy • Higher corporate incomes will lead to increased tax revenue • Companies will hire more people to help meet the demand • Newly-hired & Government handout-recipients will increase spending Chapter 11

  30. The Keynesian Idea: • Borrow money & overspend in the short-term to get the economy back on it’s feet • Pay it back when the economy gets healthy Chapter 11

  31. Keynesian: AS is small, so AD! AS New AS New AD AD Real GDP New Real GDP Chapter 11

  32. The Keynesian Downside • Government is competing with consumers for goods • Higher prices • Taxes will have to be raised in the future • Government short-term borrowing will increase interest rate, limiting new Investment Chapter 11

  33. Old vs. New Classicals: • Old Classicals • AS perfectly vertical • no short term changes • it only shifts out by shocks. • rGDP determined by AS shifts • only prices from AD shifts Chapter 11

  34. Old Classicals New AS AS New New AD New AD Real GDP New Real GDP Chapter 11

  35. Old vs. New Classicals: • New Classicals: • Unexpected price changes can change rGDPin short run • Unexpected changes in AS, money supply, or fiscal policy will change rGDP • Government managing AD will result in: • rGDP change if unexpected • Price changes if expected Chapter 11

  36. New Classicals New AS AS New AD AD Real GDP New Real GDP Chapter 11

  37. Old vs. New Keynesian: • Old Keynesians: • Technology change is so slow that AS was flat, so... • Prices are constant “sticky” so… • Changing Aggregate Expenditures will determine real GDP • Manage economy by managing AD Chapter 11

  38. Old Keynesians AS New AD AD Real GDP New Real GDP Chapter 11

  39. Old vs. New Keynesian: • New Keynesians • They agreed: AS is sloped upward. • Wages are sticky too, because of wage contracts, efficiency wages, & minimum wages • You can still manage the economy by managing AD Chapter 11

  40. Keynesian: AS is small, so AD! AS New AS New AD AD Real GDP New Real GDP Chapter 11

  41. Monetarists: • New Keynesians say changing money supply will change investment • Monetarists say consumption will also change • Both Investment & consumption changes will be short-run • In long-run rGDP will be at the natural rate of unemployment Chapter 11

  42. Monetarists: • The economy tends toward equilibrium, so government intervention isn’t necessary • Rules should be set & followed to let the economy solve itself Chapter 11

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