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.
= 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)
= Govt. Revenue (T) > Govt. Spending (G)
See back of book, From 1960-1997 we have had a deficit
except 1960 (close to a balanced
budget), and 1969 (surplus). From 1998-2001 we had budget surpluses. Why?
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
: 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
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