551-12 - Chapter 12 Fiscal Policy Incentives and Secondary...

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Chapter 12 - Fiscal Policy: Incentives and Secondary Effects We now look at Fiscal Policy. We assume that the money supply (MS) is fixed, monetary policy is held constant so we can isolate and focus on fiscal policy only. Fiscal policy = Tax policy (T) and government spending (G) by the President and Congress, with the intention to affect the economy - promote growth, achieve low unemployment, etc. Budget Deficits and Surpluses - Since fiscal policy involves a) setting tax policy to generate tax revenue (T), and b) federal spending (G), we start by discussing Budget Surpluses and Deficits. Balanced budget = Govt. Revenue (taxes, tariffs, fees) = Govt. Spending, (T = G) Budget Deficit = Govt. Spending (G) > Govt. Tax Revenue (T) Budget Surplus = Govt. Revenue (T) > Govt. Spending (G) See back of book, From 1960-1997 we have had a deficit every year except 1960 (close to a balanced budget), and 1969 (surplus). From 1998-2001 we had budget surpluses. Why? Important distinction: Budget Deficit vs. National debt - Budget Deficits occur in years when G > T, have averaged between $100-200B per year in the 80s and 90s. The National Debt is the accumulation of past budget deficits, which is now (2003) over $7000B or $7T. The federal budget is the primary tool of fiscal policy - attempt at stabilization and fine-tuning. Budget deficits can change for two reasons: 1. Passive budget deficits - without a change in fiscal policy, deficits can reflect the current state of the economy. Examples : deficit increases during recession. Tax receipts (T) are down during recession and govt. spending (G) increases. During an expansion, T goes up and G goes down due to the strong economy, leading to a smaller deficit, or a budget surplus which we currently have in U.S. 2. Active Budget deficits - result from deliberate, discretionary fiscal policy where policymakers plan the federal budget with the intention to spend more than they plan to take in (G > T, leading to a deficit) U.S. budget deficits are mostly from discretionary fiscal policy, and when we talk about a "change in fiscal policy," we are referring to a change discretionary fiscal policy that affects the deficit or surplus. KEYNESIAN VIEW OF FISCAL POLICY Before Keynes (and up to the 1960s), balanced budgets were generally accepted by politicians and the public as the responsible thing. Keynes challenged the desirability of balanced budgets. Argued that federal budget should be used to promote AD/full employment, especially during a recession. Fed Budget influences AD two ways: MGT 551: BUSINESS ECONOMICS CH – 12 Professor Mark J. Perry 1
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1. Govt. spending on goods and services affects AD (G in C + I + G). National defense, highways, education, etc. Increases in federal spending increases G in GDP, cuts in federal spending decreases G. 2. Tax policy (T) influences AD. A tax cut increases disposable income, increases Consumption (C
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This note was uploaded on 01/23/2012 for the course FIN 551 taught by Professor Staff during the Spring '11 term at University of Michigan.

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551-12 - Chapter 12 Fiscal Policy Incentives and Secondary...

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