Balanced Budget Multiplier by yyp14196

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									Chapter 9: The
Government
and Fiscal Policy
                    Outline

I. Government in the economy
II. How fiscal policy works? Multiplier effects.
  1. The government spending multiplier
  2. The tax multiplier
  3. The balanced-budget multiplier
III. The federal budget
IV. The economy’s influence on the
  government budget
I. Government in the Economy

 Government can affect the macroeconomy
 in two ways:
     Fiscal policy

     Monetary policy
I. Government in the Economy

   Discretionary fiscal policy refers to
    deliberate changes in taxes or spending.


   The government can not control certain
    aspects of the economy related to fiscal
    policy.
The Budget Deficit
 A government’s budget deficit is the difference
  between what it spends (G) and what it collects in
  taxes (T) in a given period:


             Budget deficit  G  T
   • If G exceeds T, the government must
     borrow from the public to finance the
     deficit. It does so by selling Treasury
     bonds and bills. In this case, a part of
     household saving (S) goes to the
     government.
Disposable Income (Yd)
 Disposable, or after-tax, income (Yd )
  equals total income minus taxes.


               Yd  Y  T
   Adding Net Taxes (T) and Government
Purchases (G) to the Circular Flow of Income

   When government enters the picture, the aggregate
    income identity gets cut into three pieces:


                       Yd  Y  T
                       Yd  C  S
                    Y  T  C S
                    Y  C S  T
     • And aggregate expenditure (AE) equals:

                  AE  C  I  G
Adding Taxes to the
Consumption Function
                C  a  bYd
                 Yd  Y  T

                C  a  b( Y  T )
 The aggregate consumption function is now a
  function of disposable, or after-tax, income.
        Equilibrium Output: Y = C + I + G
                           C  100 .75Yd                       C  100.75(Y  T )
         Finding Equilibrium aggregate output for I = 100, G = 100, and T =
         100 (All Figures in Billions of Dollars)

  (1)     (2)        (3)              (4)             (5)       (6)        (7)          (8)         (9)           (10)
                                                             PLANNED              PLANNED   UNPLANNED
 OUTPUT   NET    DISPOSABLE     CONSUMPTION         SAVING INVESTMENT GOVERNMENT AGGREGATE INVENTORY         ADJUSTMENT
(INCOME) TAXES     INCOME         SPENDING             S     SPENDING PURCHASES EXPENDITURE   CHANGE             TO
    Y      T      Yd = Y  T   (C = 100 + .75 Yd)   (Yd – C)     I        G        C+I+G    Y  (C + I + G) DISEQUILIBRIUM

  300    100        200              250             50       100         100           450        150       Output ↑
  500    100        400              400                0      100         100           600        100       Output ↑
  700    100        600              550              50       100         100           750         50       Output ↑
  900    100        800              700             100       100         100           900              0   Equilibrium
1,100    100      1,000              850             150       100         100         1,050        + 50      Output ↓
1,300    100      1,200            1,000             200       100         100         1,200       + 100       Output ↓
1,500    100      1,400            1,150             250       100         100         1,350       + 150      Output ↓
Finding Equilibrium
Output/Income Graphically
The Leakages/Injections Approach
 Taxes (T) are a leakage from the flow of income.
  Saving (S) is also a leakage.
 In equilibrium, aggregate output (income) (Y) equals
  planned aggregate expenditure (AE), and leakages
  (S + T) must equal planned injections (I + G).
  Algebraically,


                AE  C  I  G
                Y  C S  T
            C S  T  C I  G
               S T  I  G
Adding Net Taxes (T) and Government Purchases
(G) to the Circular Flow of Income
II. 1. The Government Spending Multiplier

 The government spending multiplier is the
 ratio of the change in the equilibrium level of
 output to a change in government spending.


                                        1
      Government spending multiplier 
                                       MPS
        II. 1. The Government Spending Multiplier

Finding Equilibrium After a $50 Billion Government Spending Increase
(All Figures in Billions of Dollars; G Has Increased From 100 in Table 25.1 to 150 Here)

  (1)      (2)       (3)           (4)           (5)       (6)         (7)          (8)         (9)          (10)
                                                        PLANNED               PLANNED   UNPLANNED
 OUTPUT   NET  DISPOSABLE CONSUMPTION          SAVING INVESTMENT GOVERNMENT AGGREGATE INVENTORY          ADJUSTMENT
(INCOME) TAXES   INCOME      SPENDING             S     SPENDING  PURCHASES EXPENDITURE   CHANGE             TO
    Y      T   Yd = Y  T (C = 100 + .75 Yd)   (Yd – C)     I         G        C+I+G    Y  (C + I + G) DISEQUILIBRIUM

  300     100       200           250           50       100         150          500        200       Output ↑
  500     100       400           400              0      100         150          650        150       Output ↑
  700     100       600           550            50       100         150          800        100       Output ↑
  900     100       800           700          100        100         150          950         50       Output ↑
1,100     100     1,000            850          150       100         150         1,100           0      Equilibrium

1,300     100     1,200         1,000           200       100         150         1,250        + 50       Output↓
II. 1. The Government Spending Multiplier
II. 2. The Tax Multiplier

 A tax cut increases disposable income, and
  leads to added consumption spending.
  Income will increase by a multiple of the
  decrease in taxes.
 A tax cut has no direct impact on spending.
  The multiplier for a change in taxes is smaller
  than the multiplier for a change in
  government spending.
II. 2. The Tax Multiplier

                                                     1 
 Y  (initial increase in aggregate expenditure)       
                                                     MPS 

                           1              MPC 
   Y  (   T  MPC )          T       
                           MPS            MPS 

                                 MPC 
             Tax multiplier        
                                 MPS 
II. 3. The Balanced-Budget Multiplier

 The balanced-budget multiplier is the ratio
  of change in the equilibrium level of output to
  a change in government spending where the
  change in government spending is balanced
  by a change in taxes so as not to create any
  deficit.
        II. 3. The Balanced-Budget Multiplier

Finding Equilibrium After a $200 Billion Balanced Budget Increase in G and T
(All Figures in Billions of Dollars; G and T Have Increased From 100 in Table 25.1 to
300 Here)
  (1)       (2)      (3)            (4)          (5)        (6)          (7)            (8)               (9)
                                                  PLANNED              PLANNED     UNPLANNED
 OUTPUT     NET  DISPOSABLE     CONSUMPTION INVESTMENT GOVERNMENT AGGREGATE        INVENTORY          ADJUSTMENT
(INCOME)   TAXES   INCOME         SPENDING        SPENDING PURCHASES EXPENDITURE     CHANGE               TO
    Y        T    Yd = Y  T   (C = 100 + .75 Yd)     I        G        C+I+G      Y  (C + I + G)   DISEQUILIBRIUM

  500      300      200            250          100        300           650          150            Output ↑
  700      300      400            400          100        300           800          100            Output ↑
  900      300      600            550          100        300           950            50           Output ↑
1,100      300      800            700          100        300         1,100                  0       Equilibriu
                                                                                                         m
1,300      300    1,000            850          100        300         1,250           + 50           Output ↓
1,500      300    1,200          1,000          100        300         1,400         + 100            Output ↓
    Fiscal Policy Multipliers

Summary of Fiscal Policy Multipliers
                                                             FINAL IMPACT
                      POLICY STIMULUS            MULTIPLIE        ON
                                                    R        EQUILIBRIUM Y
Government-      Increase or decrease in the
spending         level of government                1             1
                                                             G
multiplier       purchases:                        MPS           MPS


Tax multiplier   Increase or decrease in the       MPC               MPC
                 level of net taxes:                          T 
                                                   MPS                MPS


Balanced-        Simultaneous balanced-budget
budget           increase or decrease in the         1
multiplier       level of government purchases                       G
                 and net taxes:
III. The Federal Budget
 The federal budget is the budget of the
  federal government.
 The difference between the federal
  government’s receipts and its expenditures is
  the federal surplus (+) or deficit (-).
      III. The Federal Budget
 Federal Government Receipts and Expenditures, 2000 (Billions of
 Dollars)
                                                                                   PERCENTAGE
                                                                        AMOUNT      OF TOTAL
 Receipts
      Personal taxes                                                     1,010.1        49.6
      Corporate taxes                                                      193.2         9.5
      Indirect business taxes                                              111.0         5.5
      Contributions for social insurance                                   720.6        35.4
                 Total                                                   2,034.9       100.0
 Current Expenditures
      Consumption                                                          514.1        26.9
      Transfer payments                                                    831.9        43.6
      Grants-in-aid to state and local governments                         274.2        14.4
      Net interest payments                                                236.9        12.4
      Net subsidies of government enterprises                               52.5         2.7
                Total                                                    1,909.6       100.0
 Current Surplus (+) or deficit () (Receipts  Current Expenditures)    + 125.3
Source: U.S. Department of Commerce, Bureau of Economic Analysis.
The Federal Government Surplus (+) or
Deficit (-) as a Percentage of GDP, 1970 I2003 II
The Debt

  The federal debt is the total amount
   owed by the federal government. The
   debt is the sum of all accumulated
   deficits minus surpluses over time.
  Some of the federal debt is held by
   the U.S. government itself and some
   by private individuals. The privately
   held federal debt is the private (non-
   government-owned) portion of the
   federal debt.
The Federal Government Debt as a
Percentage of GDP, 1970 I2003 II




  The percentage began to fall in the mid 1990s.
IV. The Economy’s Influence
on the Government Budget
   Automatic stabilizers are revenue
    and expenditure items in the federal
    budget that automatically change with
    the state of the economy in such a
    way as to stabilize GDP.
IV. The Economy’s Influence
on the Government Budget
   Fiscal drag is the negative effect on
    the economy that occurs when
    average tax rates increase because
    taxpayers have moved into higher
    income brackets during an expansion.
IV. The Economy’s Influence
on the Government Budget
   The full-employment budget is what
   the federal budget would be if the
   economy were producing at a full-
   employment level of output.
IV. The Economy’s Influence
on the Government Budget
   The cyclical deficit is the deficit that
    occurs because of a downturn in the
    business cycle.
   The structural deficit is the deficit
    that remains at full employment.
Review Terms and Concepts
 automatic stabilizers                fiscal drag
 balanced-budget multiplier           fiscal policy
 budget deficit                       full-employment budget
 cyclical deficit                     government spending multiplier
 discretionary fiscal policy          monetary policy
 disposable, or after-tax,            net taxes
    income                            privately held federal debt
 federal budget                       structural deficit
 federal debt                         tax multiplier
 federal surplus (+) or deficit (-)

								
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