SAYRE | MORRIS Seventh Edition Fiscal Policy CHAPTER 7 7-1© 2012 McGraw-Hill Ryerson Limited

Fiscal Policy Government’s approach toward its own spending and taxation Minister of finance brings down annual budget in Parliament each spring Contains estimates of government’s revenues and expenditures 7-2© 2012 McGraw-Hill Ryerson Limited LO1 Fiscal Policy

Table 7.1 Federal Government Budget Year Ending March © 2012 McGraw-Hill Ryerson Limited LO1 REVENUES Personal income taxes103.9 Corporate and other income taxes36.0 E.I. premiums16.8 GST and excise and energy taxes40.6 Nontax revenues21.6 Total Revenues OUTLAYS Transfers to persons68.6 Spending grants to other levels of govt57.0 Public debt charges29.4 Direct program spending119.2 Total Outlays274.2 Projected Budget Plan Deficit55.6 Source: Data derived by authors from information found in Department of Finance; Annual Report to the Government Reproduced with the permission of the Minister of Public Works and Government Services, 2010.

Net Tax Revenue total tax revenue received by government less transfer payments Budget Balance the difference between net tax revenues and government spending 7-4© 2012 McGraw-Hill Ryerson Limited LO1 Fiscal Policy NTR = tax revenue  transfer payments Budget Balance = NTR - G

Budget Surplus net tax revenue in excess of government spending on goods and services Budget Deficit government spending on goods and services in excess of net tax revenues 7-5© 2012 McGraw-Hill Ryerson Limited LO1 Fiscal Policy

National Debt the sum of the federal government’s budget deficits less its surpluses Balanced Budget the equality of net tax revenues and government spending on goods and services 7-6© 2012 McGraw-Hill Ryerson Limited LO1 Fiscal Policy

Table 7.2 Net National Debt (current $ billion) 6-7© 2012 McGraw-Hill Ryerson Limited LO1 YearBudget SurplusBudget DeficitNet National Debt 1940— — — — — — — — — — — — — — — — — —− —− Department of Finance: Fiscal Reference tables October 2010.

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The government budget is affected by: the level of the GDP A change in the amount of government spending A change in the amount of government revenue (taxation) 7-10© 2012 McGraw-Hill Ryerson Limited LO1 Fiscal Policy

John Maynard Keynes: Developed model in response to the depression Based on aggregate expenditures: AE = C + I + G + Xn Believed depression was caused by decreased aggregate expenditures Argued for increased government expenditures to increase employment and incomes Increased spending financed through borrowing 7-11© 2012 McGraw-Hill Ryerson Limited LO2 Countercyclical Fiscal Policy

Counter-Cyclical Fiscal Policy Chapter Dealing with a recessionary gap: - raise G and/or lower T - total spending increases to AD 2 - shifts economy back to potential GDP Dealing with a recessionary gap: - raise G and/or lower T - total spending increases to AD 2 - shifts economy back to potential GDP Y FE Y1Y1 P Real Y AD 1 AD 2 AS 1 Potential GDP  G G Recessionary gap LO2

Counter-Cyclical Fiscal Policy Chapter Y FE Y1Y1 P Real Y AD 2 AD 1 AS 1 Potential GDP  G G Inflationary gap Dealing with an inflationary gap: - lower G and/or raise T - total spending decreases to AD 2 - shifts economy back to potential GDP Dealing with an inflationary gap: - lower G and/or raise T - total spending decreases to AD 2 - shifts economy back to potential GDP LO2

Summary: When there is a recessionary gap, governments should spend and tax in a way that increases aggregate demand. When there is an inflationary gap, governments should spend and tax in a way that reduces aggregate demand. 7-14© 2012 McGraw-Hill Ryerson Limited LO2 Countercyclical Fiscal Policy

Shortcomings: it is subject to serious time lags it has an inflationary bias it can cause serious budget deficits 7-15© 2012 McGraw-Hill Ryerson Limited LO2 Countercyclical Fiscal Policy

the government budget is balanced in each fiscal period addresses the shortcomings of a countercyclical fiscal policy relies on automatic stabilizers (tax laws and spending programs that cut back spending during a boom and increase spending in a slowdown) based on belief that economy will return to full employment on its own 7-16© 2012 McGraw-Hill Ryerson Limited LO3 Balanced Budget Fiscal Policy

Chapter Recessionary gap: - eventually wages will be forced down -AS increases, returning economy to Y FE - also decreases price level Recessionary gap: - eventually wages will be forced down -AS increases, returning economy to Y FE - also decreases price level Y FE Y1Y1 P Real Y AD AS 1 Potential GDP  Wages Recessionary gap LO2 AS 2 AS would increase because we know that when a productive resource decreases (wages), supply increases.

Shortcomings: Procyclical: pushing the economy further in the same direction it is going balanced budget is procyclical in a recessionary gap, because low tax revenues create deficits may be procyclical in an inflationary gap, if it is accompanied by a budget surplus 7-18© 2012 McGraw-Hill Ryerson Limited LO3 Balanced Budget Fiscal Policy

the use of countercyclical fiscal policy to balance the budget over the life of the business cycle no guarantee that size and length of recessionary gap will be exactly offset by the size and length of the inflationary gap most governments find it easier to increase spending in bad times than to decrease it in good times 7-19© 2012 McGraw-Hill Ryerson Limited LO4 Cyclically Balanced Budget Fiscal Policy

government borrows by issuing bonds debt held by individuals, corporations, and financial institutions interest payments represent redistribution of wealth from all taxpayers to relatively wealthy bondholders 7-20© 2012 McGraw-Hill Ryerson Limited LO5 Fiscal Policy and National Debt

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debt increased significantly to finance WWII debt increased again since 1970s increase in income-support programs high interest rates in 1970s and 1990s since 1995, Canada’s debt fell to lowest of G8 7-22© 2012 McGraw-Hill Ryerson Limited LO5 Fiscal Policy and National Debt

Problems with High Deficits / Debt: the interest payments that must be paid on the foreign-held debt the income redistribution effects of large interest payments the reduced ability of government to meet the needs of its citizens the possible increased power grabbing and wastefulness of government 7-23© 2012 McGraw-Hill Ryerson Limited LO5 Fiscal Policy and National Debt

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