Chapter 12 Government and Fiscal Policy

1. Chapter 12 Government and Fiscal Policy

2. 1. MONETARY POLICY IN THE UNITED STATES Learning Objectives • Understand the major components of U.S. government spending and sources of government revenues. • Define the terms budget surplus, budget deficit, balanced budget, and national debt, and discuss their trends over time in the United States.

3. 1.1 Government Purchases

4. 1.2 Transfer Payments • Atransfer payment is the provision of aid or money to an individual who is not required to provide anything in exchange (e.g. social security, food stamps, welfare).

5. 1.2 Transfer Payments

6. 1.3 Taxes

7. 1.4 The Government Budget Balance • A budget surplus is a situation that occurs if government revenues exceed expenditures. • A budget deficit is a situation that occurs if government expenditures exceed revenues. • A balanced budget is a situation that occurs if the budget surplus equals zero.

8. Government Revenue and Expenditure as a Percentage of GDP, 1960-2007

9. 1.5 The National Debt • National debt is the sum of all past federal deficits, minus any surpluses. • The national debt and the economy, 1929-2007

10. Debts and Deficits for 26 Nations, 2006

11. 2. THE USE OF FISCAL POLICY TO STABILIZE THE ECONOMY Learning Objectives • Define automatic stabilizers and explain how they work. • Explain and illustrate graphically how discretionary fiscal policy works and compare the changes in aggregate demand that result from changes in government purchases, income taxes, and transfer payments.

12. 2.1 Automatic Stabilizers • An Automatic stabilizer is any government program that tends to reduce fluctuations in GDP automatically (e.g. various transfer payments and income taxes).

13. 2.2 Discretionary Fiscal Policy Tools • Expansionary and contractionary fiscal policies to shift aggregate demand. SRAS SRAS LRAS LRAS P1 P2 P2 P1 AD1 AD2 AD2 AD1 Y1 YP YP Y1

14. 2.3 Changes in Government Purchases • An increase in government purchases of $200b. SRAS P2 G P1 AD Multiplier AD2 AD1 $12,000 12,300 12,400

15. 2.5 Changes in Income Taxes • A change in income taxes shifts the AD curve by a multiple of the initial change in consumption (which is less than the change in personal disposable income) that the change in income taxes causes.

16. 2.6 Changes in Transfer Payments • As with income taxes, a change in government transfer payments shifts the AD curve by a multiple of the initial change in consumption (which is less than the change in personal disposable income) that the change in transfer payments causes.

17. Fiscal Policy in the United States Since 1964

18. Fiscal Policy in the United States Since 1964

19. 3. ISSUES IN FISCAL POLICY Learning Objectives • Explains how the various kinds of lags influence the effectiveness of discretionary fiscal policy. • Explain and illustrate graphically how crowding out (and its reverse) influences the impact of expansionary or contractionary fiscal policy. • Discuss the controversy concerning which types of fiscal policies to use, including the arguments from supply side economics.

20. 3.1 Lags • Discretionary fiscal policy is subject to the same lags discussed for monetary policy. • Fiscal implementation lags are likely to be more pronounced. • Fiscal impact lags are likely to be less pronounced.

21. 3.2 Crowding Out • Crowding out is the tendency for an expansionary fiscal policy to reduce other components of aggregate demand. • Increased government spending raises interest rates causing less consumption and investment. • Crowding in is the tendency for a contractionary fiscal policy to increase other components of aggregate demand. • Less government spending lowers interest rates causing more consumption and investment.

22. An Expansionary Fiscal Policy and Crowding Out S1 S2 S2 S1 SRAS E2 P2 P1 P1b P2b E1 D2 D1 D1 AD1 AD2 AD3 Y1 Y2

23. 3.3 Choice of Policy • Supply side economics is the school of thought that promotes the use of fiscal policy to stimulate long run aggregate supply.