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MacroEcon Chapter 12

# MacroEcon Chapter 12 - Chapter 12 Fiscal Policy Changes in...

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Chapter 12: Fiscal Policy Changes in government purchases, transfer payments and taxes I. Short Run: Countercyclical Fiscal Policy Long run/classical model- fiscal policy had no demand-side effects Cannot influence total output; Consumption and Investment spending would be crowded out Short-run: increase in G can increase in total spending through multiplier and raise equilibrium In the short run, fiscal policy has demand-side effects on output and employment Continue adjust own purchases or net taxes, government could keep economy closer to potential output- avoid recessions and avoid booms (cause inflation) Countercyclical fiscal policy: a change in government purchases or net taxes designed to reverse or prevent a recession or a boom A. Mechanics of Countercyclical Fiscal Policy originally 10k (point A) but some component of spending decreases so the AE line decreases we must go back to 10k- so either increase G or cut net taxes (government tax revenues – transfer payments) I. Change in Government Purchases Most direct way to cure recession with fiscal policy Ex: how much G would have to rise to bring us back to full employment? Change in GDP/required change (Triangle sign) Change in GDP= multiplier x change in G We want equilibrium GDP to be 10k (10k-9k=1k) 1000 billion= 2.5 x G G= 400\$ billion

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If G rises by \$400 million, AE is back to normal B. Change in Net Taxes More indirect way Net taxes (differences between taxes & transfer payments) By cutting taxes or increasing transfers, government can increase spending of those directly affected. (households who get tax cut or receive transfer payments) Multiplier case is different from government purchases Ex: decrease net taxes (T) by \$1 billion, immediate impact is by \$1 billion. There would be a change in D.I. should cause a change in spending 1. First C will increase by MPC x 1 billion (.6 x 1 bil= \$600 billion – initial rise in spending by tax cut) Once it rises by \$600 billion, multiplier works with any other change in spending C rises by \$360 billion (.6 x 600billion) Compare government purchases and cut in net taxes Net taxes: 60% of value in government purchases Therefore, final rise in GDP from \$1000 billion tax cut must be 60% of rise in GDP that we get from G (\$1000 purchase) (T) multiplier: amount by which real GDP changed for each one-dollar change in net taxes In the short-run model, the tax multiplier is the marginal propensity times the expenditure multiplier, and negative in signs Net tax multiplier= -MPC x expenditure multiplier Ex: expenditure multiplier: (1/1-mpc) so tax multiplier is -MPC x (1/1-mpc)= -MPC/1-MPC so MPC of .6= -.6/1-.6= (-1.5) Change in GDP= net tax multiplier x change in Net taxes \$1000= -1.5 x change in T T= -666.7 billion
If net taxes decreases by this number, then AE line will shift upward A tax cut or increase in transfer payments of this amount must total this number II. Problems with Countercyclical fiscal policy since 1990’s, economists were skeptical of using fiscal countercyclical policies 4 major reasons why: A. Timing Problems Usually takes months + for fiscal policies to be enacted

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MacroEcon Chapter 12 - Chapter 12 Fiscal Policy Changes in...

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