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Unformatted text preview: MACROECONOMICS EXAM III Chapter 11 Fiscal Policy (Definitions) Crowding out: a drop in consumption or investment spending caused by government spending Discretionary Fiscal Policy: changes in government spending and taxation that are aimed at achieving a policy goal Automatic Stabilizer: an element of fiscal policy that changes automatically as income changes Progressive Tax: a tax whose rate rises as income rises Transfer Payment: a payment to one person that is funded by taxing others Value-added tax (VAT): a general sales tax collected at each stage of production (Power Point) Fiscal Policy • Fiscal Policy: (government spending and taxation) is one tool that government uses to guide the economy along an expansionary path • By varying the level of government spending, policymakers can affect the level of real GDP Multiplier Effects • If the price level rises as real GDP increases, the multiplier effects of any given change in AE are smaller than they would be if the price level remained constant • Government spending must be financed by some combination of taxing, borrowing, and creating money • Government Spending = taxes + change in government debt + change in government issued money Government Spending Financed By Tax Increases • Government increases spending, but finances it with tax increases • The increase in spending shifts the AD to the right, but the increase in taxes reduces the incentive to work, shifting AS to the left Government Spending Financed By Borrowing • Debt is, in a way, a substitute for current taxes. Taxes will have to be higher in the future in order to provide the government with funds to pay off the debt • Ricardian Equivalence: is the principle that government spending activities financed by taxation or borrowing have the same effect on the economy • Alternatively, the public does not base current spending on future tax liabilities • Research on the issue continues, with supporters on both sides Crowding Out • An increase in government spending financed by borrowing can reduce consumption and investment • As interest rates are driven higher by government borrowing, private investment is “crowded out” by debt-financed government spending Fiscal Policy • Discretionary Fiscal Policy: changes in government spending and/or taxation aimed at achieving a policy goal • Automatic Stabilizer: an element of fiscal policy that changes automatically as income changes Implication of Deficits and National Debt • Crowding out means a smaller future capital stock and lower output in the future • Higher interest rates cause currency appreciation, leading to import increase and net export decreases, reducing GDP. This is international crowding out • Higher national debt means higher interest payments paid by the government Automatic Stabilizers • Progressive Taxes: a tax whose rate rises as income rises- U.S. income taxes currently range from a rate of 10% to 35% depending upon annual income •...
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