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Fiscal Policy

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					Fiscal Policy
  Discretionary Fiscal Policy
Changes at the option of gov’t
For beginning, assume: 1) no effect
planned private spending, 2) no effect on
AS
  Expansionary Fiscal Policy
1) increase G
– Multiplier effect: GDP jumps; if in horizontal zone,
  growth output w/o inflation; unemployment falls
2) reduce taxes
– Smaller MPC, greater tax cut necessary for same
  multiplication ($6.67B $5B AE $20B GDP)
3) use both
Create budget deficit
           AE Recessionary Gap


AE
                                  C+G+I+XN0



                             C+G+I+XN1




     490         510             rGDP
                 AS
PL




     AD0   AD1

                      rGDP
 Contractionary Fiscal Policy
Restrain demand-pull inflation
1) decrease G
– Negative multiplier effect
2) raise T
– Reduces S by MPS, reduces C by MPC;
  greater tax cut than spending cut
3) combine
Create budget surplus
     AE Inflationary Gap


AE




                            rGDP
           510        530
     AS
PL




             AD0



      AD1



          rGDP
 Financing Deficits + Disposing of
            Surpluses
Servicing the Deficit
 1) Borrow crowding out effect reduces
 private spending reduces expansionary
 impact
 2) Money creation (monetary policy): both
 more expansionary and inflationary
          Loanable Funds Market

Real Interest
Rate                        Slf



           r1
           r



                                  Dlf1
                            Dlf

                Q   Q1   Quantity of
                         Loanable Funds
   Budget surplus anti-inflationary?
No: pay down debt buy back bonds
money back into money market IR fall
more borrowing and spending
Yes: impounding, “lock box”
               G or T?
Liberals: increase spending in recessions,
raise taxes during expansion
Conservative: tax cuts during recession,
cut spending during expansion
 Nondiscretionary Fiscal Policy:
  Built-In/Automatic Stabilizers
Increases deficit during recession,
increases surplus during expansion w/o
policy change
Direct relationship GDP and net taxes
– Transfer payments: “negative taxes”
– More progressive (average tax rate: T
  rev/GDP; direct relationship) more stability
    Vs. proportional (constant avg TR) or regressive
    (avg TR inversely related)
G and
T                                             T


                                   Surplus


                                      G

        Deficit




                  rGDP   More progressive =
                         steeper slope
Economic importance:
1) Taxes reduce S and AD
2) Stability benefits from taxes, and the
more progressive the better: regressive
taxes (State) make the problem worse
– Can diminish but not correct major changes
  eGDP
Actual vs. Full-Employment Budget
 Built-in stabilizers mean can’t tell if actual
 budget deficit/surplus is
 expansionary/neutral/contractionary
 Actual budget more than fiscal decisions
 about G and T, must also look at level of
 GDP
                                   T

                 e        a
                                       G




             d
                              b
Cyclical
deficit=cd


                     c




                 GDP y2   GDP y1
Actual ≈ Nominal
Full-employment Budget ≈ Real
Measures budget if economy at full-employment
throughout year
Structural deficit: reflects configuration G and T
independent of GDP
Discretionary fiscal policy deliberate changes in
full-employment deficit
Actual = Structural + Cyclical
Structural tells if budget
expansionary/neutral/contractionary
Balanced Budget Amendment
Effectively eliminate fiscal policy
Would lead to worsening recessions:
1) Increase T
2) Reduce G
3) Combination
 contractionary
         T2

                   T1

 a                      G1




     b




GDP y2    GDP y1
                   T1


  a                      G1




                        G2
      b




GDP y2    GDP y1
     Fiscal Policy Problems
                 Timing
1)Recognition lag
– Indicators hard to read/slow to appear
2) Administrative lag
– Talk, talk, talk; don’t you wish we lived in a
  dictatorship?
3) Operational lag
– Tax changes take effect faster
                    Political
Stability not sole goal
– Employment Act 1946
– War, equality, equity, anti-discrimination, etc.
State and Local gov’t
– Pro-cyclical
Expansionary Bias
– And taxes bad
Political Business Cycle
– Short-term memory: 2-3 year cycles of tax cutting and
  gov spending (pre-election) followed by tax hikes and
  budget balancing
– Not fully supported by evidence
Criticisms of Crowding-Out Effect
Effect during recession limited improved
profit expectations may offset higher IR
Monetary policy: “accommodative”
monetary policy (expand M) reduce
effect (1960s); “tight” (hold M steady)
increase effect (1980s)
Aggregate Supply and Inflation
Fiscal policy that pushes AD into
intermediate range output “dissipated”
into inflation
     FP in Open Economy
Globalization may increase fluctuations,
certainly complicates fiscal policy
AD shocks: unexpected growth foreign
consumers causes overshot of FP
     Intended Expansionary Policy
                                    AS
PL




                     AD0     AD1

                                         rGDP
     Actual Effect w/AD Shock
                                 AS
PL




                                             AD2

                   AD0     AD1

                                      rGDP
AD shocks could also cause overshot of
contractionary policy
– Could theoretically correct for timing problems
Net Export Effect
Expansionary policy crowding-out
higher IR increased foreign financial
capital in US (higher rate of return for
creditor) higher demand US $ (required
for investment) appreciation (higher
value US $) US goods more expensive
abroad lower net exports reduces
expansion, offsetting FP
Contractionary policy has opposite effect
– However: lower/higher foreign input prices
  shifts AS, offsetting effect

				
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posted:5/8/2013
language:English
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