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Principles of Macroeconomics

Principles of Macroeconomics. Chapter 12:Fiscal Policy. Fiscal Policy – Keynesian region. Fiscal policy – intermediate region. Fiscal policy – classical region. Multipliers. Government spending multiplier = 1 / (MPS + MPI)

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Principles of Macroeconomics

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  1. Principles of Macroeconomics Chapter 12:Fiscal Policy

  2. Fiscal Policy – Keynesian region

  3. Fiscal policy – intermediate region

  4. Fiscal policy – classical region

  5. Multipliers • Government spending multiplier = 1 / (MPS + MPI) • Lump-sum tax multiplier = -(MPC-MPI) / (MPS + MPI) • Balanced-budget multiplier = effect of equal changes in G and T = 1

  6. Government budget constraint • Government spending = taxes + change in government debt + change in government-issued money

  7. Tax finance of government spending • Balanced-budget multiplier = 1 • Offsetting effects: • Incentive effects may reduce labor supply and cause a reduction in AS • Laffer curve

  8. Deficit financing of government spending • Ricardian equivalence: • Individuals may save more in response to higher expected future taxes • Crowding out: • Increased borrowing leads to higher interest rates; resulting in a reduction in I and C (discussed more extensively shortly)

  9. Monetary expansion used to finance government spending • Due to autonomy of Fed, this is less likely to occur in the U.S. today. • If used, tends to be inflationary, resulting in a reduction in C.

  10. Discretionary fiscal policy vs. automatic stabilizers • Discretionary fiscal policy: changes in government spending, taxes, and/or transfer payments to achieve a macroeconomic policy goal • Automatic stabilizers: automatic increase in transfers and tax reductions as income falls (the reverse holds when income rises) • Examples: unemployment compensation, income tax, welfare programs. • Automatic stabilizers reduce the value of the multiplier.

  11. Tax structures • Proportional tax: Tax / income is constant as income rises • Progressive tax: Tax / income rises as income rises • Regressive tax: Tax / income declines as income rises

  12. Deficits and debt • Deficit = G – T = amount by which government spending exceeds net taxes • Debt = total stock of outstanding government bonds • Deficit = a flow variable • Debt = a stock variable

  13. Deficits, interest rates, and investment • Loanable funds model

  14. Demand for loans

  15. Supply of loans

  16. Equilibrium

  17. Increase in deficit

  18. Costs of deficit • Crowding out: higher interest rates result in less investment • Higher deficit results in currency appreciation and a decline in net exports (X) • Interest payments – redistribution of income • Regressive? • Foreign debt holdings

  19. Foreign fiscal policy • Share of GDP devoted to G is smaller in the U.S. than in most developed economies • Value-added taxes are commonly used in most other developed economies

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