CAN GOVERNMENT CURE A SICK ECONOMY WITH FISCAL POLICY?????

1. CAN GOVERNMENT CURE A SICK ECONOMY WITH FISCAL POLICY?????

2. Government Shutdown Averted- What’s the big Deal??

3. What is Fiscal Policy Anyway?Usually Countercyclical in nature Deliberate changes in government spending or taxing to Achieve full employment Control inflation Encourage economic growth

4. Fiscal Policy What tools can the federal government use to alter macroeconomic outcomes? Taxing and spending in a variety of combinations. Can Taxing and spending alterations ensure full-employment? What policy actions will help fight inflation/ deflation? What are possible risks of government intervention?

5. Where does the power to tax original from?

6. Article I, Section 8, U.S. Constitution 1789- “to lay and collect taxes, duties, imposts, and excises, to pay the debts and provide for the common defense and general welfare of the United States.” 1913- 16th Amendment allowed the federal government to collect from individuals…

7. Terms to Know Automatic fiscal policy a change in fiscal policy caused by the state of the economy. (unemployed- pay fewer taxes.) Discretionary fiscal policy a policy action initiated by an Act of Congress Expansionary fiscal policy government should either increase its purchases of g&s or cut its taxes. (causes govt to borrow.)

8. Discretionary Decision by Congress (discretionary spending) Government can alter aggregate demand by: Give examples………………. • Purchasing more or fewer goods and services • Raising or lowering taxes • Changing the level of income transfers

9. Government gets serious about Aggregates in 40’s Employment Act of 1946 After WWII…the unemployment issues needed to be addressed. “Employment Act of 1946 passed- commits the Federal government to use all practicable means, consistent with the market system, to createeconomic conditions under which there will be…. employment opportunities, including self-employment for those able, willing, and seeking work, and to promote maximum employment production, and purchasing power.”

10. The Employment Act: Commits Federal government to take action through monetary and fiscal policy to maintain economic stability.

11. Humphrey-Hawkins Full Employment Act • This Act passed in 1978 and set up specific policy requirements for the Fed. • Created the dual mandate for Fed- unemployment and inflation guages • This charge has specifically been assigned to the Federal Reserve (sans the fiscal part)…

12. The Executive branch responsible for fulfilling the PURPOSE of the ACT. Advisory groups to President: CEA (Council of Economic Advisors) JEC (Joint Economic Committee of Congress)

13. Purpose is to Shift Aggregate Demand either right or left… depending on needs for stability.

14. Expansionary and Contractionary Fiscal Policy: Changes in Government Spending If there is a recessionary gap in panel (a), fiscal policy can presumably increase aggregate demand

15. Expansionary and Contractionary Fiscal Policy: Changes in Government Spending If there is an inflationary gap, fiscal policy can presumably decrease aggregate demand

16. Tax Cut More consumption = MPC X tax cut More saving = MPS X tax cut More consumption More consumption More income More income More saving More saving Cumulative change in saving: = tax cut The Tax Cut Multiplier First round of spending: Second round of spending: Third round of spending:

17. Multiplier Effect This is a simple explanation of how we can jumpstart an economy…. Potentially!!! What do we normally like to do if we win the lottery

18. The Multiplier The Multiplier:-- The multiple by which an initial change in spending will alter total expenditure after an infinite number of spending cycles; • An increase in spending by one party increases the income of others. Thus, an increase in spending can expand output by a much larger amount. • The multiplier is the number by which the initial change in spending is multiplied to obtain the total amplified increase in income. • The size of the multiplier increases with the marginal propensity to consume (MPC).

19. In evaluating the importance of the multiplier, one should remember: The Multiplier • taxes and spending on imports will dampen the size of the multiplier; • it takes time for the multiplier to work; and, • the amplified effect on real output will be valid only when the additional spending brings idle resources into production without price changes.

20. Multiplier Formula Multiplier is ______1_____ 1 – MPC When money is spent by someone, it becomes someone else’s income. When someone spends adollar, perhaps someone who received that dollar would spend 80 cents..next person would spend 64 cents…If you add up the spending created by that one dollar, it will add up to four or five times that dollar… hence “the multiplier”

21. The multiplier principle applies in reverse also. (decrease, yields reduction) (money in shoe box) Marginal Propensity to Consume is the key *Income increases- we spend some on “more stuff” In turn consumption expenditures on “stuff” will generate additional income for others who will spend part of their income on “stuff” also. There is a direct correlation between expenditure multiplier and MPC.

22. The Multiplier Process 3. Income reduced by $100 billion 4. Consumption reduced by $75 billion Households 7. Income reduced by $75 billion more 8. Consumption reduced by $56.25 billion more Factor markets Product markets 9. And so on 6. Further cutbacks in employment or wages 5. Sales fall $75 billion Business firms 2. Cutbacks in employment or wages 1. $100 billion in unsold goods appear

23. Marginal Propensity To Consume AdditionalIncome(Dollars) AdditionalConsumption(Dollars) ExpenditureStage Round 1 3/4 Round 2 3/4 Round 3 3/4 Round 4 3/4 Round 5 3/4 Round 6 3/4 Round 7 3/4 Round 8 3/4 Round 9 3/4 Round 10 3/4 3/4 All Others Total 4,000,000 3,000,000 3/4 For simplicity (here) it is assumed that all additions to income are either spent domestically or saved. The Multiplier Principle 1,000,000 750,000 750,000 562,500 562,500 421,875 421,875 316,406 316,406 237,305 237,305 177,979 177,979 133,484 133,484 100,113 100,113 75,085 75,085 56,314 225,253 168,939 • The multiplier concept is fundamentally based upon the proportion of additional income that households choose to spend on consumption: the marginal propensity to consume (here assumed to be 75%  3/4).

24. Government Going Into Debt! If government year after year engages in deficit spending… (more spending less revenue)… then the national debt will mount. DUH!!! That’s the big controversy right now… Will we spend ourselves into a 3rd world nation.

25. Public Debt on Daily Report • http://www.publicdebt.treas.gov/

26. Government expenditures rise- taxes remain the same- what has to give? • Government borrow the difference. • Has to offer higher interest rates to attract takers • This is the interest rate effect of expansionary fiscal policy • When interest rates go up, businesses less apt to invest, consumers less apt to purchase interest sensitive g & s

27. How does government pull this off? • Borrowing from the public.. This is done by selling interest-bearing bonds.*most likely will drive up interest rates and “crowd out private investments. (*note this is where foreign money is so important to the U.S. government and can put us in considerable peril if overdone) **also note any decline in private spending will weaken or reduce the expansionary effect of deficit spending.

28. Possible Offsets to Fiscal Policy Crowding-Out Effect The tendency of expansionary fiscal policy to cause a decrease in planned investment or planned consumption in the private sector; this decrease normally results from the rise of interest rates.

29. Remember Crowding Out Government comes in and makes financial investments so attractive that it crowds out the private sector… The big-time investor will want to seek the best rate of return, and anytime government wants, they can make that be the scenario.

30. Second way for government to overspend • Money Creation • The Central Bank creates new money and private spending is not affected by expansionary efforts of the fiscal aspects. • **** this means that… Federal spending can continue without disrupting private spending or investment….Referred to monetizing the debt.(more $$ in circulation – debt goes “poof.”) • Print money to pay the bill! • **** Problem is it is very inflationary… (Too many $$$ chasing too few goods)

31. What is the relationship between tax receipts and GDP??? • Increased Taxes reduce consumer spending… and aggregate demand… • These reductions would be favored if moving toward inflation… but increases in spending would be favored if economy is slumping. • So… we have inflation Unemployment ? • What % of GDP does consumption take up?

32. So… answer this question!! What is the limit for Congress to spend in any given year? Where does the limit come from? Is it stationary or floating? Is this a question that our current government is faced with?????

33. 3 Questions to Ask About Economic Stability • Can government spending and taxing ensure full employment? • What fiscal policy actions will help fight inflation • What are the risks of government intervention

34. What happens if the Fed pulls back and decides to balance the budget? Will a tax cut hurt or help the budget? Does it matter who gets the tax cut? How would the multiplier work here?

35. Who Decides? Which is the better way to eliminate recession and inflation? (government spending or taxes) The answer here is whether you want big government or “smaller” government.

36. Possible Offsets to Fiscal Policy Supply-Side Economics The suggestion that creating incentives for individuals and firms to increase productivity will cause the aggregate supply curve to shift outward

37. Possible Offsets to Fiscal Policy Question Would a tax increase cause you to work more or less or about the same?

38. Figure 13-5 Laffer Curve Tax revenues are at a maximum Tax rates and tax revenues rise together Tax rates and tax revenues fall together

39. Terms to Know Automatic fiscal policy a change in fiscal policy caused by the state of the economy. (unemployed- pay fewer taxes. Tax rate) Discretionary fiscal policy a policy action initiated by an Act of Congress Expansionary fiscal policy government should either increase its purchases of g&s or cut its taxes. (causes govt to borrow.)

40. Automatic Stabilizers Automatic orBuilt-In Stabilizers ( should these be changed today???) Changes in government spending and taxation that occur automatically without deliberate action of Congress The tax system Unemployment compensation Welfare spending

41. Why Stabilize? Idea for automatic stabilizers is to mitigate the changes in disposable income. Reminder: these are things that kick-in without a vote by Congress.

42. Automatic Stabilizers The automatic changes tend to drive the economy back toward its full-employment output level

43. Discretionary Fiscal Policy in Practice: Coping with Time Lags - Fiscal results Long – a policy designed to correct a recession may not produce results until the economy is experiencing inflation. (9-12 months) Variable in length – they can be from 1-3 years, and the timing of the desired effect cannot be predicted. (unemployment) Because fiscal policy time lags tend to be variable, policymakers have a difficult time fine-tuning the economy.

44. 3 Kinds of Taxes • Progressive tax- = tax rate/GDP rises with GDP. • Proportional tax = average tax rate remains constant as GDP rises. • Regressive tax system = average tax rate falls as GDP rises. • The progressive tax system is greater built-in stabilizer… BUT….proportional tax will ultimately bring in more revenue remember Laffer curve).

45. Axiom to remember….. Always! Increased taxes reduce spending and Aggregate Demand Reductions in spending are desirable when economy is moving toward inflation Or Increases in spending are desirable when economy is moving toward a slump.

46. Timing!!!!! Often times the move either way for Congress and/or Admin is slow to realize Administrative lag….. Takes time to digest all the fiscal data and decide what to suggest. Operational Lag…usually a 9 to 12 month period before any fiscal move can actually take affect in the real world… work projects, money into economy… Congress passing the Bill and lots of pork added. Remember… Porkbarrelling!!!

47. Leading Indicators • Average workweek • Initial claims for unemployment insurance. • New orders for consumer goods • Vendor preferences (delivery status) • New orders for capital goods • Building permits for houses • Stock prices • Money supply • Interest-rate spread(smaller difference between short term and long term rates usually spells decline of GDP) • Consumer expectations

48. If government reduces taxes and increases spending… created budget deficit…*this is where we are now Deficit spending = use of borrowed funds to finance government expenditures that exceed tax revenues Budget Deficit= amt which govt spending exceeds govt revenues (specific time period) Surplus= ………..

49. Discretionary and automatic spending. Each year… Pres/Congress put together budget blueprint for next fiscal year. OMB and CBO… Fiscal year for federal government = October 1 Cyclical Deficits = portion of budget deficit attributable to unemployment or inflation Structural Deficit = whatever does not fall into cyclical falls into structural (created deficits by works of Congress)

50. Let’s Talk about DEBT Accumulation of Debt: When Treasury borrows funds it issues treasury bonds. Treasury bonds = promissory notes (IOUs) issued by the U.S. Treasury. Total stock of all outstanding bonds represent national debt.