FISCALPOLIC

Y

FISCALPOLIC

Y

12C H A P T E R

LEGISLATIVE MANDATESLEGISLATIVE MANDATES

•Employment Act of 1946•Commits the Federal Government to take action on the economy

•Council of Economic Advisors (CEA) Assist the President

•Joint Economic Committee (JEC) Assist Congress

•Employment Act of 1946•Commits the Federal Government to take action on the economy

•Council of Economic Advisors (CEA) Assist the President

•Joint Economic Committee (JEC) Assist Congress

FISCAL POLICY AND THE AD-AS MODELTwo Options

• Discretionary Fiscal Policy •“Active”•May cause a budget deficit

• Non-Discretionary Fiscal Policy•“Passive” or Automatic stabilizers

Expansionary Fiscal Policy• Increase Government Spending• Tax Reductions• Combinations of the Two

Pri

ce le

vel

Real GDP (billions)

EXPANSIONARY FISCAL POLICY

Full $20 billionincrease in aggregatedemand

AD2AD1

$5 billion initialincrease in spending

the multiplier at work...

P1

$485 $505

Pri

ce le

vel

Real GDP (billions)

CONTRACTIONARY FISCAL POLICY

the multiplier at work...

P3

$515

Full $20 billiondecrease in aggregatedemand

AD4

AD3

$5 billion initialdecrease in spending

P4

FINANCING OF DEFICITS ANDDISPOSING OF SURPLUSES

•Borrowing vs. New Money•Borrowing From The Public•Money Creation

•Debt Retirement vs. Idle Surplus•Debt Reduction•Impounding

Which Policy Option? G or T?

BUILT-IN STABILITY

Net tax revenues vary directly with GDP

Transfer payments behave the opposite way as tax collections

Automatic or Built-In Stabilizers

Economic Importance

BUILT-IN STABILITY

GDP1 GDP2 GDP3

Real Domestic Output, GDP

Gov

ern

men

t E

xpen

dit

ure

s,G

, an

d T

ax R

even

ues

, T

Deficit

Surplus

T

G

BUILT-IN STABILITY

Tax Progressivity• Progressive Tax System• Proportional Tax System• Regressive Tax System

The more progressive the tax system, the greater the economy’s built-in stability

EVALUATING FISCAL POLICY

Full-Employment BudgetCyclical DeficitRecent U.S. Deficits & Surpluses

Year

ActualDeficit orSurplus

Full-EmploymentDeficit orSurplus

19901991199219931994199519961997199819992000

-3.9%-4.5-4.7-3.9-2.9-2.2-1.4-0.3+0.8+1.4+2.4

-2.1%-2.6-3.0-2.6-2.0-1.9-1.2-0.9-0.4+0.3+1.1

FULL-EMPLOYMENT DEFICITS

GDP2 GDP1

Real Domestic Output, GDP

Gov

ernm

ent

Exp

endi

ture

s,G

, and

Tax

Rev

enue

s, T

(bi

llio

ns)

G

T1

Year 1Year 2

ab

c$500 475 450 425

No Change inFiscal Policy

FULL-EMPLOYMENT DEFICITS

GDP4 GDP3

Real Domestic Output, GDP

Gov

ernm

ent

Exp

endi

ture

s,G

, and

Tax

Rev

enue

s, T

(bi

llio

ns) T2

G

T1

Year 3Year 4

de

f$500 475 450 425

DiscretionaryFiscal PolicyTax Decrease

h

g

PROBLEMS, CRITICISMS,AND COMPLICATIONS

•Problems of Timing•Recognition Lag•Administrative Lag•Operational Lag

•A Political Business Cycle?•Offsetting State & Local Finance

•Crowding-Out Effect

FISCAL POLICY, AGGREGATE SUPPLY AND INFLATION

Pric

e le

vel

Real GDP (billions)

AS

AD2

$495 $515

P1

AD1

Fiscal Policy:Pure & Simple

FISCAL POLICY, AGGREGATE SUPPLY AND INFLATION

Pric

e le

vel

Real GDP (billions)

AS

AD’2

$495 $515

P1

AD1 Fiscal Policyand the

Crowding-OutEffect or theNet Export

Effect

$505

AD2

FISCAL POLICY, AGGREGATE SUPPLY AND INFLATION

Pric

e le

vel

Real GDP (billions)

AS

AD2

$495 $515

P1

AD1

Fiscal PolicyAnd Inflation

$505

FISCAL POLICY IN THE OPEN ECONOMY

Shocks Originating from Abroad

Net Export Effect

SUPPLY-SIDE FISCAL POLICY

Emphasis on Expansionary Tax Cuts

Impact upon...• Saving and Investment

• Work Incentives

• Risk Taking

SUPPLY-SIDE FISCAL POLICY

0

Pri

ce le

vel

Real domestic output, GDP

AD1

AD2

AS1 AS2

P1

P2

P3

Q1 Q2 Q3

Forecasting the FutureThe Leading Indicators

• Average Workweek• Initial Claims for Unemployment

Insurance• New Orders for Consumer Goods• Vendor Performance• New Orders for Capital Goods• Building Permits for Houses• Stock Prices• Money Supply• Interest-Rate Spread• Consumer Expectations

Forecasting the FutureThe Leading Indicators

• Average Workweek• Initial Claims for Unemployment

Insurance• New Orders for Consumer Goods• Vendor Performance• New Orders for Capital Goods• Building Permits for Houses• Stock Prices• Money Supply• Interest-Rate Spread• Consumer Expectations

ChapterConclusions

ENDBACK

fiscal policy

Employment Act of 1946

Council of Economic Advisers (CEA)

expansionary fiscal

policy

budget deficit

contractionary fiscal

policy

budget surplus

built-in stabilizer

progressive tax system

proportional tax

system

regressive tax system

full-employment

budget

cyclical deficit

political business cycle

crowding-out effect

net export effect

supply-side fiscal policy

Copyright McGraw-Hill/Irwin, 2002

Chapter 13

Moneyand

BankingNext...