cowenecon3e_lectureslides_macro_18_econ_ch37

cowenecon3e_lectureslides_macro_18_econ_ch37 - Chapter 37...

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MODERN PRINCIPLES OF ECONOMICS Third Edition Fiscal Policy Fiscal Policy Chapter 37
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Introduction In 2008, the U.S. economy was heading into a severe recession. In the third quarter of 2008, consumer spending dropped by 3.7%. To encourage spending, the government sent rebate checks to millions of US taxpayers. In 2009, hundreds of billions of dollars were spent on infrastructure. Both are examples of fiscal policy. 2
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Definition Fiscal policy : Federal government policy on taxes, spending, and borrowing that is designed to influence business fluctuations. 3
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Introduction We will use aggregate demand and aggregate supply to understand fiscal policy. Two general categories of fiscal policy are used to fight a recession: 1. The government spends more money. 2. The government cuts taxes, giving people more money to spend. The first increases government spending while the second increases private sector spending. 4
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Fiscal Policy: The Best Case A decrease in consumer spending growth, , is equivalent to a decrease in velocity, . AD shifts to the left. The economy moves from a long-run equilibrium at point a to a short-run equilibrium at point b . Because wages are sticky, the decline in velocity is split between lower real growth and lower inflation. The economy goes into a recession. 5 C v
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(1) During a recession, ↓ AD 6 0% 3% 6% 7% -1% SRAS ( = 7%) LRAS b a Inflation Rate ( ) Real GDP growth rate Fiscal Policy: The Best Case 10%) M AD v ( 5%) M AD v ( C
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Fiscal Policy: The Best Case If government does nothing, in the long run wages will adjust. The economy will eventually return to its normal growth rate. Since the components of AD are , , , and , the government can offset a ↓ by . The increase in government spending will cause the recession to end sooner. 7 C G I NX C G
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(1) During a recession, ↓ AD (2) Govt. ↑ spending, ↑ AD 8 0% 3% 6% 7% -1% SRAS ( = 7%) LRAS b a Inflation Rate ( ) Real GDP growth rate Fiscal Policy: The Best Case 10%) M AD v ( 5%) M AD v ( C
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Fiscal Policy: The Best Case An increase in means the government is spending more money. The money must come from taxes or increased borrowing. This reduces AD from some quarters, thereby making the government spending less effective. However, spending can increase growth when the economy is operating inefficiently. The increase puts the economy back on track.
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