Slides prepared by Muni Perumal, University of Canberra, Australia Fiscal Policy 2012 Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia

Slides prepared by Muni Perumal, University of Canberra, Australia Learning Objectives Discuss the implications of and complications associated with fiscal policy within the aggregate demand–aggregate supply framework Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia

Federal Government Finance Federal expenditures large expenditure on social security and welfare specific purpose grants Federal revenues Personal income tax Company income tax Indirect and other taxes GST excise tax Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia

Discretionary Fiscal Policy The deliberate manipulation of taxes and spending by government for the purpose of altering real GDP and employment, controlling inflation and stimulating economic growth Not all fiscal policy is deliberate, a range of automatic stabilisers are discussed later Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia

Expansionary Fiscal Policy Increased government spending or lower taxes or increased transfer payments (social security payments) to reduce the effects of recession, i.e. boost GDP and reduce unemployment Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia

Expansionary Fiscal Policy AS1 ASLS AD1 AD2 Price level P2 Q2 P1 Q1 Qp Real gross domestic product Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia

Contractionary Fiscal Policy Decreased government spending or higher taxes or a reduction in transfer payments in order to reduce inflation during a boom Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia

Contractionary Fiscal Policy AS1 ASLS AD2 AD1 Price level P2 P1 Q1 Qp Real gross domestic product Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia

Non-Discretionary Fiscal Policy Built-in or automatic stabilisers that operate without requiring explicit action by policy-makers, they are the result of a progressive income taxes and a social security system During recessions: Tend to increase government deficits (or reduce surplus) through lower taxes and higher welfare payments During inflationary periods: Tend to increase government surpluses (or reduce deficits) through higher taxes and lower welfare payments Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia

Automatic or Built-in Stabilisers Tax receipts: Increase as real GDP increases, so the economy slows Transfers: Decrease as real GDP increases, but increase when the economy slows so GDP and AD increase. Do not fully correct the economy, only reduces the severity of fluctuations Useful when economy is operating around full employment Can cause problems: Fiscal Drag Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia

Automatic or Built-in Stabilisers Flatten out the fluctuations in the business cycle, but do not eliminate them completely Level of business activity Time Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia

Problems with Fiscal Policy in Practice Problems of timing Recognition lags Administrative lags Operational lags Political problems Other economic goals, economic growth complements and conflicts with other policies Expansionary bias, often not used stimulate rather than slow the economy The political cycle may accentuate the business cycle. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia

Fiscal Policy and Aggregate Supply Fiscal policy, especially tax changes, affects not only aggregate demand but can affect aggregate supply Tax changes in the form of incentives to businesses and individuals as well as government spending in infrastructure can lead to a rightward shift in the AS in addition to increasing AD, providing a further stimulus to the economy in terms of lower prices and higher GDP Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia

Supply-Side Effect of Fiscal Policy AS2 AS1 ASLS AD1 AD2 Price level P2 Q2 P3 = Q3 P1 Q1 Qp Real gross domestic product Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia