LECTURE5 (2009)

# LECTURE5 (2009) - ECON 1002 Introductory Macroeconomics...

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1 1 Introductory Macroeconomics Week 5 Fiscal Policy Money, Prices and the Reserve Bank ECON 1002

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2 Remember: 5 main macroeconomic objectives 1. Rising long term living standards 2. The price level is under control 3. The needs for savings and investment are balanced 4. All individuals seeking work are employed 5. Extreme short run economic fluctuations are avoided Rationales for those 5 main goals of macroeconomic policies can be found in lectures 1, 2 and 3
3 The Keynesian short run aggregate expenditure model e 45 0 Y PAE 5400 Y*=6400 6400 C + I + G + NX

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4 The Keynesian short run aggregate expenditure model: example C = 640 + c (Y-T) c = 0.8 T = 150 I = 60 G = 300 NX = 200 PAE = 640 + 0.8(Y-150) + 60 +300+200 PAE = 1200 +0.8Y -120 PAE = 1080 +0.8Y This means that every additional dollar of income will increase PAE by 80 c. The exogenous part of the PAE equals 1080
5 The Keynesian short run aggregate expenditure model: example Since in equilibrium Y =PAE then PAE = 1080 +0.8Y = Y Y-0.8Y= 1080 Y = 1080/0.2 =5400 Equilibrium GDP is 5400. But what if potential GDP is 6400? We have an deflationary gap. What can the government do? GDP is 1000 unit below potential GDP. Given a multiplier of 5, the government will aim to increase PAE by 200 units. It can attempt to do so using fiscal policy

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6 What is fiscal policy? To fine-tune (or stabilize) the economy (ie smooth out economic fluctuations) and achieve a full-employment and non- inflationary level of GDP, the government manipulates aggregate expenditure by changing government expenditures (G) and/ or net taxes (T)
7 An active fiscal policy: definition An active fiscal policy attempts to smooth out the fluctuations in the economy. This is called fine- tuning or stabilization When the economy is booming, taxes (taxes less transfer payments) are increased and government spending is reduced to dampen aggregate expenditure (contractionary fiscal policy) When the economy is slowing down so much that unemployment is increasing, an active fiscal policy would mean increasing government expenditure and lowering taxes so as to boost aggregate expenditure (expansionary fiscal policy)

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8 A few definitions Budget balance Headline versus underlying budget balance Structural versus cyclical deficit Active versus passive fiscal policy
9 The budget balance 1. Budget deficit: Government expenditure>tax revenue (taxes less Transfers) 1. Budget surplus: Government expenditure<tax revenue (taxes less transfers)

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10 Headline versus underlying budget balance Headline budget balance = government receipts including asset sales – government expenditure Underlying budget balance = government receipts, excluding asset sales – government expenditure
11 Assessing the fiscal stance: structural versus cyclical budget balances Is the Government is pursuing an expansionary or contractionary fiscal policy? Or is it pursuing any active fiscal policy at all? To assess the fiscal stance, the underlying budget

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LECTURE5 (2009) - ECON 1002 Introductory Macroeconomics...

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