October 17 notes

October 17 notes - Fiscal Policy Controversies REQUIRED...

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: Fiscal Policy Controversies REQUIRED READING CHAPTER 11, INCLUDING APPENDICES A & B What are the Important Fiscal Policy Controversies? • Activism • “Fine-Tuning” v. “Broad-Tuning” • Spending v. Tax Policies • Supply-Side Economics • Obama Stimulus Package Fiscal Policy Activism Model : Yd D( P, C , I , Ao , G, TR, TX , t ) Fiscal Instruments Ys Yd S ( P, Wo , Z o , TEo , K o ) Ys Can/Should the government use fiscal tools to counter business cycle movements or to achieve certain targets? Recession: Use Expansionary Policy 1st Step Recession: Use Expansionary Policy 2nd Step Can the government offset the reaction? Trade-offs: Expansionary Policies Social Benefit: Achieves Y^Tar (higher target level of real income) Social Cost: Higher P (or inflation) -Have to weigh costs with benefits- High Prices: Use Contractionary Policy 1st Step High Prices: Use Contractionary Policy 2nd Step Trade-offs: Contractionary Policies Social Benefit: Achieve Target Price Social Cost: Decline in real income and output (Y), which could increase unemployment Using Fiscal Policy to “Fine-Tune” the Economy Can/Should the government Concensus is no: • Problems: use activist fiscal policy to fine-tune the P or Y? Difficulty in Predicting precisely the Effects of Fiscal Policy Overshooting the target Prediction Problems: An Example • Assume Target is to Increase Y by $300 billion Government Purchase Multiplier = 2 Government decides to increase Military Spending by $150 billion • Estimates of the Multiplier are 1.5 to 2.5 • Effect on Y can then vary from $225 billion to $375 billion Can undershoot or overshoot the target. Overshooting Problems • Lags in Conduct of Fiscal Policy Implementation Lag Lag in the Effect on the Economy • Shifts in Private Spending Overshooting a Real Income Target <--- Political lag causes an overshoot from Y target because economic situation changes 1. implementation lag -political squabbling 2. Lag in conduct -Once congress decides on what action to take, the effects take time ---------> Can take a year to two years for effects to happen, in that time, things can change. Overshooting a Price Level Target “Broad-Tuning” • Use Activist Fiscal Policy to counter Serious or Big problems with the economy Deep Recession Unemployment of 7-10% or higher Use Expansionary Fiscal Policies High Price Level or High Inflation Inflation of 10-12% per year or Higher Use Contractionary Fiscal Policies Unwise for government to undertake fine-tuning fiscal policy, but okay for serious problems. Spending v. Tax Policies • Question: To achieve Targets with Fiscal Policies, should the Government use: Changes in Government Purchases? Changes in Transfer Payments? Changes in Taxes? What Are the Issues? • Key Determinant: Mainly Long-term political views on the Size of the Government • Economic Effects: Usually not critical for the Effectiveness of Fiscal Policies to counter undesirable business cycle movements -What instrument you choose to change doesn't usually matter • Political Effects: Spending changes, Tax changes, or Transfer changes can be Difficult to Eliminate once enacted Basic Conflicts Advocates of Bigger Government in US advocate: Expansionary Policies: Contractionary Policies: G or TX or TR t Advocates of Smaller Government in US advocate: Expansionary Policies: TX or t Contractionary Policies: G or TR Supply-Side Economics • Personal Tax Cuts—Designed to Increase Labor Supply • Business Tax Cuts—Designed to Increase Saving, Investment & Capital Formation Modified Aggregate Supply Curve Ys OTE , S ( P, Wo , Z o , TEo , K o , t ) t Ys Another variable that decides position of aggregate supply curve is marginal tax rate. -Lower marginal tax rates increase work effort as households try to achieve higher levels of income. Why? Because if lower marginal tax rates and raise income, can keep a bigger part of income! Can: 1) Work more hours 2) Second job 3) 2nd unemployed person in house can get job Effects on AS A Supply-Side Tax Cut: Supply-Side Effects A Supply-Side Tax Cut: Supply-Side & Demand-Side Effects Problems in Practice Effects on aggregate demand happen quickly, and aggregate supply, slowly Another Problem-Deficits Some Supply-side advocates argued that a raise tax revenues, i.e., But, in most economies, tY If taxes go down, but real income goes extraordinarily high, tax revenues might actually go up t will Will discuss more fully later t would tY and Deficits Potential Long-Run Effects ...
View Full Document

This note was uploaded on 01/20/2012 for the course ECON 180.101 taught by Professor Maccini during the Fall '08 term at Johns Hopkins.

Ask a homework question - tutors are online