Problems of Timing•Recognition Lag•AdministrativeLag•Operational LagPolitical Considerations•Political Business CycleFuture Policy ReversalsOffsetting State and Local FinanceCrowding-Out EffectCurrent Thinking on Fiscal PolicyFiscal PolicyProblems, Criticisms, and Complications20.2
S.A. PublicDeficit/Surplus1995 - 2013as a Percentage of GDP1995−4.61996−5.11997−5.01998−3.71999−2.82000−2.12001−1.92002−1.42003−1.12004−2.32005−1.52006−0.32007+0.72008+0.92009−1.22010-4.82011-4.12012-5.32013-5Source: .
Debt and GDPThe Investment Demand Curveand the Crowding-Out Effect5101520253035400246810121416Real Interest Rate (Percent)Investment Demand (Billions of Dollars)ID1ID2abcInterest RateRise WillDecreaseInvestmentato bCrowding-Out EffectA Large Public Debt to Finance Public Investment Will Cause…If Public SpendingSpurs More PrivateInvestment WillIncrease to ID2
Stabilising the economyThe government stabilises economic fluctuations in several ways:1. Government spending is large and exogenous2. Higher tax rate lowers the multiplier3. Unemployment insurance helps households smooth consumption•Failure of private market because ofcorrelated risk, hiddenactions, hidden attributes4. Deliberate intervention via fiscal policyThe unemployment benefit scheme and proportional tax rate areautomatic stabilizers= they automatically offset an expansion orcontraction of the economy.
The multiplier in practiceIn our model of aggregate demand, the multiplier depended onlyon the marginal propensity to consume, the marginal propensity toimport, and the tax rate.In reality, it also depends on: