Chapter 11

Chapter 11 - Chapter 11 - Modern Macroeconomics: Fiscal...

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Chapter 11 - Modern Macroeconomics: Fiscal Policy We now look at Fiscal Policy. We assume that MS is fixed. Hold monetary policy constant. Fiscal policy = Tax and Spend by President and Congress. Budget Deficits and Surpluses - Since fiscal policy involves tax and spend (inflow/outflow) we start by discussing Budget Surpluses and Deficits. Balanced budget = Gov Revenue (taxes, tariffs, fees) = Govt. Spending Budget Deficit = Gov Spending > Gov Rev Budget Surplus = Gov Rev > Gov Spending 1958-1996 Deficit every year except 1969 (surplus). See back of book. Deficit vs. National debt - Deficit is an annual concept (Income stmt). National debt is the accumulation of deficits. Federal budget is the primary tool of fiscal policy - attempt at stabilization and fine- tuning. Budget deficits happen for two reasons: 1. Active Budget deficits - result from deliberate, discretionary fiscal policy where policymakers plan to spend more than is generated in revenue. 2. Passive budget deficit - without a change in fiscal policy, deficit increases during recession. Tax receipts are down during recession. Tax receipts go up during expansion, deficit shrinks. Our deficits are mostly active. Keynesian View of Fiscal Policy - Before Keynes balanced budgets were generally accepted by politicians and the public as the responsible thing. Keynesian view challenged the desirability of balanced budgets. Argued that federal budget should be used to promote AD/full employment. Fed Budget influences AD two ways: 1. Gov spending on goods and services stimulates AD (G in C+I+G). National
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defense, highways, education, etc. 2. Tax policy influences AD. Tax cut increases disposable income, increases PCE - C goes up. Bus tax cut increases business investment on equipment, etc. Keynes argues that fluctuations in AD are the source of econ disturbances and create the bus cycle - "Animal Spirits." Policy conclusion: stabilize the econ through fiscal policy. If economy is in recession, gov should engage in Expansionary Fiscal Policy - increase gov spending and/or reduce taxes, increase budget deficit. Borrow money (to finance the deficit) from individuals, businesses or foreigners. Example - page 270. Economy is in recession at e1 due to animal spirits. Downward pressure on prices. Economy slowly adjusts from e1 to E3 in the classical model by SRAS going from SRAS1 to SRAS3. Or expansionary fiscal policy could increase AD1 back to AD2 and the economy goes back to E2. Expansionary fiscal policy (active budget deficit) - some combination of i) cut personal income taxes, ii) cut corporate taxes, iii) increase gov spending. Example: page 271. Economy expands due to increased AD/animal spirits. Upward pressure on prices, wages, int rates will eventually increase SRAS1 to SRAS3 at a higher price level. Animal spirits leading to inflation. Gov can pursue Restrictive Fiscal Policy to reduce AD1 to AD2. Restrictive fiscal policy
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Chapter 11 - Chapter 11 - Modern Macroeconomics: Fiscal...

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