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Fiscal Policy

Fiscal Policy. Fiscal policy Changes in federal taxes and purchases that are intended to achieve macroeconomic policy objectives , such as high employment, price stability, and high rates of economic growth. Automatic Stabilizers versus Discretionary Fiscal Policy.

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Fiscal Policy

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  1. Fiscal Policy Fiscal policy Changes in federal taxes and purchases that are intended to achieve macroeconomic policy objectives, such as high employment, price stability, and high rates of economic growth. Automatic Stabilizers versus Discretionary Fiscal Policy Automatic stabilizers Government spending and taxes that automatically increase or decrease along with the business cycle.

  2. Economists use the term fiscal policy to refer to changes in taxing and spending polices by: • Only state and local governments. • Only the federal government. • All levels of government, federal, state, and local. • None of the above.

  3. The Federal Government’s Share of Total Government Expenditures, 1929–2010

  4. Federal Purchases and Federal Expenditures as a Percentage of GDP, 1950–2010

  5. Federal Government Expenditures, 2010

  6. What is the relationship between government purchases and government expenditures? • Government purchases include government expenditures. • Government expenditures include government purchases. • Government purchases and government expenditures are the same thing. • Government purchases include the totality of government spending, while government expenditures do not.

  7. Federal Government Revenue, 2010

  8. In 2010, which of the following two were the largest sources of federal government revenues? • Corporate income taxes and sales taxes. • Revenue from tariffs on imports and other fees. • Individual income taxes and social insurance taxes. • Excise and other taxes.

  9. Deficits, Surpluses, and Federal Government Debt Should the government’s budget always be balanced? Should it be balanced at full employment? The Federal Budget Deficit, 1901–2009

  10. Deficits, Surpluses, and Federal Government Debt The Federal Government Debt, 1901–2006

  11. Is Government Debt a Problem? • The federal government won’t default on its debt. • It can raise the funds it needs through taxes or spending cuts to make the interest payments on the debt (now ~10 % of expend). • If an increasing debt drives up interest rates • crowding out of investment spending  lower capital stock in the long run reduced capacity of the economy to produce things • This is somewhat offset if some of the government debt was incurred to finance improvements in infrastructure(bridges, highways, ports); to finance education; or to finance R&D • But beware a debt death spiral! • Debt rises because of interest cost • Interest rate rises because debt rises • Interest cost rises because of greater debt and higher interest rate

  12. The Effects of Fiscal Policyon Real GDP and the Price Level Looks a lot like expansionary and contractionary monetary policy …except for impacts on interest rates and investment spending Fiscal Policy

  13. The Effects of Fiscal Policyon Real GDP and the Price Level A Summary of How Fiscal Policy Affects Aggregate Demand Countercyclical Fiscal Policy Don’t Let This Happen to YOU!Don’t Confuse Fiscal Policy and Monetary Policy

  14. The appropriate fiscal policy for the Fed to follow in a recession is to increase the money supply and lower interest rates. A) True B) False

  15. The Government Purchases and Tax Multipliers The Multiplier Effect and Aggregate Demand

  16. The Government Purchases and Tax Multipliers The Multiplier Effect of an Increase in Government Purchases This spending multiplier is analogous but not the same as the deposit multiplier

  17. The Government Purchases and Tax Multipliers • A cut in tax rates affects equilibrium real GDP through two channels: • A cut in tax rates increases the disposable income of households, which leads them to increase their consumption spending, and • a cut in tax rates increases the size of the multiplier effect … it reduces the rate at which purchasing power leaks from the spending stream • The less the marginal propensity to leak, the greater the spending multiplier.

  18. Crowding out A decline in private expenditures as a result of an increase in government purchases. The Limits of Using Fiscal Policyto Stabilize the Economy Money market An Expansionary Fiscal Policy Increases Interest Rates

  19. The Limits of Using Fiscal Policyto Stabilize the Economy Crowding Out in the Short Run: G up  Y up  Md up  i up  I down Y doesn’t increase as much as otherwise The Effect of Crowding Out in the Short Run

  20. The Government Purchases and Tax Multipliers Taking into Account the Effects of Aggregate Supply The Multiplier Effect and Aggregate Supply

  21. Was Fiscal Policy Expansionary during the New Deal? • Did Fiscal Policy Fail during the Great Depression? Although government spending increased during the Great Depression, the cyclically adjusted budget was in surplus most years. The mistake of 1937!

  22. The Fed’s mistake in 1937 was to increase taxes and reduce government spending when unemployment was still high. A) True B) False

  23. K e y T e r m s Automatic stabilizers Budget deficit Budget surplus Crowding out Cyclically adjusted budget deficit or surplus Fiscal policy Multiplier effect Tax wedge

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