FISCALPOLICY

# Solution keynes cut g andor t generally speaking a

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Solution (Keynes): Cut G and/or T↑ Generally speaking a) Liberals Favor high spending, high taxing – Big Government b) Conservatives Favor low spending, low taxing – Small Government For inflationary situation a) liberals T↑ b) conservatives G↓ For deflationary situation a) liberals G↑ b) conservatives T↓ GDP P AD AS Q E Q FE Inflationary gap

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The Multiplier A number which when multiply by change in expenditure gives you the resulting change in GDP The multiplier is based on 2 concepts: a) GDP is the nation’s expenditure on all the final goods and services produced during the year at market prices b) GDP = C+I+G+Xn It is obvious that if any of the components of GDP C, I, G or Xn was to go up, GDP will also go up and vice versa. However, when there is any change in spending, it will have a multiplied effect on GDP. Multiplier = 1 1 1-MPC or MPS When MPC = .5, Multiplier = 2 Applications of the Multiplier The multiplier is used to calculate the effect of changes in C, I, G on GDP Example: If spending ↑ by 10 billion and M=3, then GDP will ↑s by 30 billion THE DEFICIT DILEMMA Deficit When G > T Borrowing (every year since 1969) Deficits are not all that bad especially during recessionary periods Surpluses When T > G The last one was in 1969 ( Lyndon Johnson had pushed a 10% personal income tax surcharge through Congress) Balanced Budget When G = T Perhaps a 10 billion difference between G & T may imply a balanced budget in an economy that calls for over 2.5 trillion in T & G
PARADOX OF THRIFT If everyone tries to save more, they all will end up saving less. The paradox of thrift is not at all relevant today because we save less than 5% of our personal income. Then why talk about it? Because it does a great job of illustrating how the multiplier works. Deficits and Surpluses: The Record See Figures 5 and 6, pg. 259 (read) Why are large Deficits so Bad? 1) r↑ I↓ 2) The government has become increasingly dependent on foreign savers to finance the deficit. Foreigners currently finance over half the deficit (Japan 40%) 3) The deficit sops up over ½ the personal savings, making that much less savings available to large corporate borrowers seeking funds for new plant and equipment 4) Large deficit national debt↑ r↑ deficit↑ Robert Eisner , Robert Heilbroner and Peter Bernstein have raised the question of why the federal government, unlike large corporations, does not have 2 separate budgets an operating and a capital budget. Operating budget Day-to-day costs of providing goods, service and transfer payment Capital budget Expenditures on improving highways, airports and other infrastructure; as well as expenditures on improving human resources, e.g. health and education. It is important to point out that budget deficits do stimulate the economy

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WILL WE EVER BE ABLE TO BALANCE THE BUDGET?
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