Ch.11 - CHAPTER 11 CHAPTER FISCAL POLICY FISCAL FALL, 2010...

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Unformatted text preview: CHAPTER 11 CHAPTER FISCAL POLICY FISCAL FALL, 2010 1 The Setting for Fiscal Policy 1. 1. What causes business cycles to occur? 2. 2. What are the effects of business cycles? 3. 3. What types of policies can the government take to offset the effects of business cycles? business 4. 4. What are the different types of fiscal policy? 5. 5. 2 How do discretionary, FISCAL POLICY RELATES TO THE TAXING, SPENDING AND BORROWING ACTIVITIES OF GOVERNMENT DISCRETIONARY FISCAL POLICY AGGREGATE DEMAND AGGREGATE SUPPLY POLICY POLICY ∆G OR ∆TX OR BALANCED BUDGET CHANGE TAX RATES; REDUCE REGULATION; INCREASE COMPETITON NONDISCRETIONARY FISCAL POLICY AUTOMATIC FISCAL STABLIZERS CHANGE TRANSFER PAYMENTS AND TAX COLLECTIONS AUTOMATICALLY AS GDP RISES AND FALLS (E.G., UNEMPLOYMENT INSURANCE, INCOME TAXES, WELFARE PROGRAMS, SOCIAL SECURITY, ETC. 3 DEMAND-SIDE VERSUS SUPPLYDEMAND-SIDE SIDE FISCAL POLICIES? P. 296 Figure 21.4 (Macro 11.4) DEMAND-SIDE DISCRETIONARY DEMAND-SIDE FISCAL POLICY CHOICES FISCAL 1. Find the GDP gap (+ or - ) 1. Find 2. Choose a fiscal policy tool: A. B. B. C. Change in G, Tx constant Change in Tx, G constant Balanced Budget approach 3. Determine the multiplier for the fiscal policy tool selected. 4. Divide the multiplier into the GDP gap to determine how to use the 5 policy. DISCRETIONARY FISCAL POLICY DISCRETIONARY TO SHIFT THE AD SCHEDULE: 3 approaches approaches (1) ∆G, TX CONSTANT; (2) 1) ∆TX, G CONSTANT; and (3) ∆G = ∆TX PRICE GDP gap = 900 LEVEL (BALANCED BUDGET) (BALANCED AD2 AS AD1 2000 2900 REAL GDP Note: This example assumes a “Keynesian” 6 AS Schedule) so AS schedule horizontal. FISCAL POLICY IN THE AGG. FISCAL DEMAND--AGG. SUPPLY MODEL: The Keynesian Case: INCREASES IN G The Divide Divide PRICE LEVEL the Multiplier into the GDP Gap Gap AD2 AD1 2000 GDP gap = 900 AS REAL GDP 2900 7 TABULAR VIEW OF THE GOVERNMENTEXPENDITURES MULTIPLIER MULTIPLIER • The multiplier table shows CHANGES GDP caused by an initial The change in G with Tx constant. Assume economy initially in equilibrium. I + G = S + Tx in a closed economy. ∆ G ∆ ∆ ∆ ∆ GDP GDP DI C S A ------- ------------$100 $100 ------$100 ----$90 $90 ----$010 $010 B $000 $090 $090 $81 $009 $009 C $000 $081 $081 $73 $008 $008 D $000 $073 $073 . . . . ------------------100 1000 1000 $66 . -----900 $007 $007 Sum ----100 CONCLUSION: multiplier for ∆ G = 1/MPS SO IN THIS EXAMPLE TO RAISE EQUILIBRIUM GDP SO BY 900 GOVERNMENT EXPENDITURES MUST INCREASE BY 90. 8 FISCAL POLICY IN THE AGG. FISCAL DEMAND--AGG. SUPPLY MODEL: The Keynesian Case: REDUCTIONS IN TX TX Divide the Multiplier into the GDP Gap GDP Gap PRICE LEVEL AD2 GDP gap = 900 AD1 AS 2000 REAL GDP 2900 9 TABULAR VIEW OF THE TAX MULTIPLIER MULTIPLIER • The multiplier table shows CHANGES GDP caused by an initial The change in TX with G constant. Assume economy initially in equilibrium. I + G = S + Tx in a closed economy. ∆ ∆ ∆ ∆ ∆ Tx GDP DI C S A ------- -------$100 $000 ------- ----- ------$100 $90 $10 $90 $10 B $000 $090 $090 $81 $09 C $000 $081 $081 $73 $08. D $000 $073 $073 . . . . -------------------100 +900 1000 $66 . ----900 $07. Sum Sum --------+100 CONCLUSION: Tax multiplier is -9. It may CONCLUSION: be calculated as 1 – (multiplier for changes in government expenditures.) changes SO TO CLOSE A GDP GAP OF 900 TAXES SO MUST BE REDUCED BY 100 MUST 10 THE TAX MULTIPLIER IS SMALLER IN THE ABSOLUTE VALUE AND OPPOSITE IN FISCAL POLICY IN THE AGG. FISCAL DEMAND--AGG. SUPPLY MODEL: Keynesian Case : BALANCED BUDGET MULTIPLIER MULTIPLIER Divide the Multiplier into the GDP Gap PRICE LEVEL AD2 AD1 2000 GDP gap = 900 AS REAL GDP 2900 11 BALANCED BUDGET MULTIPLIER: BALANCED EQUAL CHANGES IN G AND TX EQUAL 1. Suppose goal is to shift AD schedule to 1. the right by +900. 2. Multiplier for G = 10 (So ∆G = +90) ∆G 3. Multiplier for Tx = -9 (So ∆Tx = - 100) 3. ∆Tx 4. Suppose ∆G = ∆Tx (balanced budget) 4. ∆G A. ∆G : + 1 * 10 = + 10 A. B. ∆Tx: +1 * -9 = - 9 C. Balanced budget multiplier = 1 C. D. So ∆G = ∆Tx = + 900 CONCLUSION: TO CLOSE A GDP CONCLUSION: GAP OF 900 BOTH GOVERNMENT EXPENDI-TURES AND TAX COLLECTIONS MUST BE INCREASED BY 900. THE 12 BALANCED BUDGET MULTIPLIER FISCAL POLICY IN THE AGG. FISCAL DEMAND--AGG. SUPPLY MODEL: The Keynesian Case: Balanced Budget The Divide the Multiplier into the GDP Gap PRICE LEVEL AD2 AD1 2000 GDP gap = 900 AS REAL GDP 2900 13 EFFECTIVENESS OF DISCRETIONARY EFFECTIVENESS FISCAL POLICY IN CHANGING REAL GDP DEPENDS ON SHAPE OF AS SCHEDULE SCHEDULE 1. Keynesian range (horizontal AS) 1. Keynesian 2. Classical range (vertical AS) 3. Intermediate range (upwardsloping AS but not vertical) 14 DISRECTIONARY FISCAL POLICY DISRECTIONARY WITH UPWARD SLOPING AS SCHEDULE SCHEDULE AS1 PRICE LEVEL AD1 AD3 AD2 2000 REAL GDP 2900 3600 15 USING FISCAL POLICY TO COMBAT USING INFLATION INFLATION Policies to shift AD schedule to the Policies left: If AS schedule is vertical: If Reduce G, Tx constant Increase Tx, G constant Reduce size of balanced budget Price level declines Unemployment rate not affected. Unemployment If AS schedule is upward-sloping: Price level declines Unemployment rate rises 16 DISRECTIONARY FISCAL POLICY TO DISRECTIONARY COMBAT EXCESS-DEMAND INFLATION INFLATION AS1 PRICE LEVEL AD1 AD2 2400 REAL GDP 3000 17 SUPPLY SIDE ECONOMICS: SUPPLY 1. Lowering marginal tax rates Lowering 2. Reducing government regulation. 2. 3. Promoting free trade 3. 4. Promoting technological change 5. Increasing worker productivity 5. through education and training. 18 DISCRETIONARY FISCAL POLICY DISCRETIONARY TO SHIFT THE AS SCHEDULE TO AS2 AS1 PRICE LEVEL AD1 560 REAL GDP 680 19 THE LAFFER CURVE: SHOWS THE THE RELATIONSHIP BETWEEN TAX RATES AND TAX COLLECTIONS P. 286 P. Total tax collections Reduction in tax rates raises tax collections in this range. D C 0% E B Tax Rate A 100% 20 Supply-Side Fiscal Policy in the AD —AS Model. AS2 AS1 PRICE LEVEL AD1 560 REAL GDP 680 21 Non-Discretionary Fiscal Policy PP. 293-295 Purpose Reduce cyclical fluctuations by Reduce reducing the value of the multiplier. reducing Examples: Examples: Income taxes Unemployment Insurance payments Social security program Welfare programs Welfare During recession: During Government outlays rise Tax collections fall Tax Budget moves to deficit 22 AUTOMATIC FISCAL STABILIZERS, P. 294 STABILIZERS, Design fiscal policy to balance the budget at full employment at $6 trillion Figure 21.3 (Macro 11.3) Automatic Fiscal Stabilizers and the Automatic Aggregate Expenditures Multiplier Aggregate AE=C+I+G+X-M 45 degree line AE2 AE1 GDP 24 ADVANTAGES AND ADVANTAGES DISADVANTAGES OF AUTOMATIC FISCAL STABILIZERS STABILIZERS Advantages Go into effect automatically Go No Congressional delays No No political battles between Congress No and the White House and Disadvantages Disadvantages Cannot reverse the direction of Cannot income and output changes Reduce the value of the multipliers for the discretionary fiscal policy tools (e.g., ∆G, ∆Tx) ∆G, 25 END CH. 11 LECTURE QUESTIONS???? 26 26 ...
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This note was uploaded on 01/12/2012 for the course ECN 211 taught by Professor Kingston during the Spring '08 term at ASU.

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