Fiscal Policy

Frederick University

2014

Fiscal policyA system of goals, tools and instruments to affect

GDP and employment

Subject – the Treasury (the Ministry of Finance) Goals: Long run or short run expansion or restriction Discretion or rule-based policy Fine tuning of the economy Stabilization policy structural policy Tools and instruments: Government revenues Government spending – government purchases and transfer

payments

Government Budget

Assessment of government revenues and expenditures, deficits and surpluses of government finance

revenuesexpenditures

TaxesG

Transfer payments

Elementary Model of Fiscal PolicyThrough G Expansion – increase in G and in AD Restriction – decrease in G and reduction in ADThrough Taxes expansion - reduction in T and increase in AD Restriction – increase in T and reduction in AD

The taxation multiplier shows the change in GDP caused by a change in the tax rate

taxation multiplier = - MPC/MPS

GDP gaps

Price level

GDP

AD AS

Y*Y1Y* - Y1 = recessionary gap

Price level

GDP

AD

AS

Y2Y*Y2 – Y* = inflationary gap

Fiscal policy on the AE diagram

AE

Y

45o

AE1

AE2

Y1

Y2

Expansionary fiscal policy – G increases and AE rise, as a result, Y rises

Budget deficit (surplus) and government debt• Budget deficit (surplus): Primary deficit (surplus) = current revenues-

current expenditures Secondary deficit (surplus) = primary deficit

(surplus) + interest payments on domestic debt

Cash deficit (surplus) = secondary deficit (surplus) + flows of external revenues and payments

• Cyclical vs. structural deficit (surplus)• Government debt

Effectiveness of the Fiscal Policy Discretionary vs. Rule-based policy Built-in stabilizers: in the budget – income taxes, corporate

taxes, social payments in the economy – excess capacity,

purchases of foreign goods, corporate dividend policy, autonomous spending

Crowding-out and crowding-in effect Time lags

Supply-side Fiscal Policy

A system of goals, tools and instruments to affect aggregate supply

Goals: Increase in productivity Reduction of the inflationary pressure Reduction in the need for government spending Reduction of government debt Reduction of the crowding-out effect

Effectiveness - Depends on the elasticity of factor supply factor

payments and disposable income

Laffer Curve

Т

t

0100%

Discussions on the effectiveness of fiscal policy

Different time horizons and different assessment of the:

Stability of the macroeconomic equilibrium

Elasticity of investment demand as regard the interest rate

Expectations – adaptive vs. rational Dynamics of the aggregate supply