FISCAL POLICY 12 C H A P T E R

LEGISLATIVE 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 MODEL Two 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

Price level Real GDP (billions) EXPANSIONARY FISCAL POLICY Full $20 billion increase in aggregate demand AD 2 AD 1 $5 billion initial increase in spending the multiplier at work... P1P1 $485 $505

Price level Real GDP (billions) CONTRACTIONARY FISCAL POLICY the multiplier at work... P3P3 $515 Full $20 billion decrease in aggregate demand AD 4 AD 3 $5 billion initial decrease in spending P4P4

FINANCING OF DEFICITS AND DISPOSING 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 GDP 1 GDP 2 GDP 3 Real Domestic Output, GDP Government Expenditures, G, and Tax Revenues, 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 Budget Cyclical Deficit Recent U.S. Deficits & Surpluses Year Actual Deficit or Surplus Full-Employment Deficit or Surplus % %

FULL-EMPLOYMENT DEFICITS GDP 2 GDP 1 Real Domestic Output, GDP Government Expenditures, G, and Tax Revenues, T (billions) G T1T1 Year 1Year 2 a b c $ No Change in Fiscal Policy

FULL-EMPLOYMENT DEFICITS GDP 4 GDP 3 Real Domestic Output, GDP Government Expenditures, G, and Tax Revenues, T (billions) T2T2 G T1T1 Year 3Year 4 d e f $ Discretionary Fiscal Policy Tax 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 Price level Real GDP (billions) AS AD 2 $495$515 P1P1 AD 1 Fiscal Policy: Pure & Simple

FISCAL POLICY, AGGREGATE SUPPLY AND INFLATION Price level Real GDP (billions) AS AD’ 2 $495$515 P1P1 AD 1 Fiscal Policy and the Crowding-Out Effect or the Net Export Effect $505 AD 2

FISCAL POLICY, AGGREGATE SUPPLY AND INFLATION Price level Real GDP (billions) AS AD 2 $495$515 P1P1 AD 1 Fiscal Policy And 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 Price level Real domestic output, GDP AD 1 AD 2 AS 1 AS 2 P1P1 P2P2 P3P3 Q1Q1 Q2Q2 Q3Q3

Forecasting the Future The 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 Future The 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 Chapter Conclusions

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

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