Chapter 13 - THIRD EDITION MACROECONOMICS Paul Krugman |...

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Fiscal Policy Chapter 13 THIRD EDITION MACROECONOMICS Paul Krugman | Robin Wells 1
What fiscal policy is and why it is an important tool in managing economic fluctuations Which policies constitute an expansionary fiscal policy and which constitute a contractionary fiscal policy Why fiscal policy has a multiplier effect and how this effect is influenced by automatic stabilizers Why governments calculate the cyclically adjusted budget balance Why a large public debt may be a cause for concern Why implicit liabilities of the government are also a cause for concern WHAT YOU WILL LEARN IN THIS CHAPTER 2
Government Spending and Tax Revenue Government Spending and Tax Revenue for Some High-Income Countries in 2007
Sources of Tax Revenue in the United States, 2007
Government Spending in the United States, 2007 Social insurance programs are government programs intended to protect families against economic hardship.
The Government Budget and Total Spending Fiscal policy is the use of taxes, government transfers, or government purchases of goods and services to shift the aggregate demand curve. 6
Expansionary and Contractionary Fiscal Policy Expansionary Fiscal Policy Can Close a Recessionary Gap Expansionary fiscal policy increases aggregate demand. Recessionary gap Potential output
Expansionary and Contractionary Fiscal Policy Contractionary Fiscal Policy Can Eliminate an Inflationary Gap Contractionary fiscal policy reduces aggregate demand. Inflationary gap Potential output
A Cautionary Note: Lags in Fiscal Policy In the case of fiscal policy, there is an important reason for caution: there are significant lags in its use. Realize the recessionary/inflationary gap by collecting and analyzing economic data takes time Government develops a spending plan takes time Implementation of the action plan (spending the money takes time 9
Fiscal Policy and the Multiplier Fiscal policy has a multiplier effect on the economy. Expansionary fiscal policy leads to an increase in real GDP larger than the initial rise in aggregate spending caused by the policy. Conversely, contractionary fiscal policy leads to a fall in real GDP larger than the initial reduction in aggregate spending caused by the policy. 10
Fiscal Policy and the Multiplier The size of the shift of the aggregate demand curve depends on the type of fiscal policy. The multiplier on changes in government purchases, 1/(1 − MPC ), is larger than the multiplier on changes in taxes or transfers, MPC /(1 − MPC ), because part of any change in taxes or transfers is absorbed by savings. Changes in government purchases have a more powerful effect on the economy than equal-sized changes in taxes or transfers.

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