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BU204_Krugman_Chapter 12

BU204_Krugman_Chapter 12 - > Fiscal Policy A BRIDGE TO...

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>> N 1998 THE JAPANESE GOVERNMENT completed the longest suspension bridge in the world. The 6,500-foot span linking Awaji Island to the city of Kobe cost $7.3 billion to build. Yet as skep- tics had predicted, it currently carries very little traffic—about 4,000 cars a day. By comparison, America’s longest suspension bridge, the Verrazano Bridge that links New York City’s Staten Island to the bor- ough of Brooklyn, carries more than 300,000 cars a day. In Japan, stories like this are common. During the 1990s the Japanese government spent around $1.4 trillion on in- frastructure that included many construction projects of question- able usefulness. But the main pur- pose of construction spending in Japan wasn’t to provide useful in- frastructure. It was to prop up ag- gregate demand. During the 1990s, the Japanese government built bridges, roads, dams, breakwaters, and even park- ing garages in an effort to combat persistent shortfalls in aggregate demand. Japan’s use of govern- ment construction spending to stimulate its economy is an example of discretionary fiscal policy —the deliberate use of govern- ment spending or taxation to manage ag- gregate demand. The U.S. government has also tried to spend its way out of economic A BRIDGE TO PROSPERITY? What you will learn in this chapter: What fiscal policy is and why it is an important tool in managing economic fluctuations Which policies constitute an ex- pansionary fiscal policy and which constitute a contrac- tionary fiscal policy Why fiscal policy has a multiplier effect and how this effect is influ- enced 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 AFP Getty Images I chapter 293 12 Fiscal Policy slumps, though on a smaller scale. Indeed, many countries attempt to manage aggre- gate demand by using discretionary fiscal policy. Governments also adjust taxes in an attempt to manage aggregate demand. They may reduce taxes to try to stimulate the economy or raise taxes when they believe that aggregate demand is too high. In this chapter, we will learn how discre- tionary fiscal policy fits into the model of short-run fluctuations we developed in Chapter 10. We’ll see how deliberate changes in government spending and tax policy affect real GDP. We’ll also see how changes in tax revenue caused by short-run fluctuations in GDP—an automatic response that occurs without deliberate changes in policy—help stabilize the economy. Finally, we’ll examine long-run consequences of gov- ernment debt and budget deficits. The Akashi Kaikyo Bridge was built by the Japanese govern- ment in the 1990s to prop up aggregate demand.
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294 PART 5 SHORT-RUN ECONOMIC FLUCTUATIONS Fiscal Policy: The Basics Let’s begin with the obvious: modern governments spend a great deal of money and col- lect a lot in taxes. Figure 12-1 shows government spending and tax revenue as percent- ages of GDP for a selection of high-income countries in 2003. As you can see, the
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BU204_Krugman_Chapter 12 - > Fiscal Policy A BRIDGE TO...

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