1. Unit 5 Inflation, Unemployment, and Stabilization Policies

2. Fiscal Policy
Government use of Government Spending (G) and Taxes (T) to shift AD (AS) in order to stabilize the economy
Two components of stabilization?

3. Fiscal Policy
Need Expansionary Need Contractionary

4. Fiscal Policy- Basic Terms
Surplus
Balanced Budget
Deficit
Debt

8. Fiscal Policy- Basic Terms
Discretionary v. Mandatory Spending

12. Fiscal Policy Basics Discretionary Fiscal Policy
Examples:
Stimulus Spending
Tax Cuts
Automatic Stabilizers (generally “Mandatory” programs)
Population qualifying for Food Stamp
Applicable tax bracket within progressive tax system

13. Types of Deficits

14. Types of Deficits/Surpluses
Total (Headline) Deficit/Surplus
Structural- result from underlying imbalance in government budget
Cyclical- deficit or surplus attributed to ups and downs of the business cycle

15. Types of Deficits

16. Debt to GDP Ratio
Debt/GDP X 100

17. Debt to GDP Ratio

19. Components of National Debt
National Debt- value of outstanding treasury securities (government bonds)
Debt held by Public- $13.7 trillion
Securities held by
Individuals
Corporations
Governments (state, local, and foreign (6 trillion)
Intragovernmental (Interdepartmental) Debt- $5.3 trillion
Securities held by government itself
Social Security Trust Fund

20. Fiscal Policy Expansionary Contractionary Decrease Taxes
Increase Spending and Transfers
Contractionary
Increase Taxes
Decrease Spending and Transfers

21. Policy Lags Inside Outside Recognition Decision Implementation
Impact (operational)

22. Policy Lags- Fiscal
Decision and Implementation are generally considerable

23. Inside Lags- Fiscal Fiscal- 535 members of Congress and the President
Bill becomes law process (decision)
Federal Bureaucracy (implementation)

24. Outside Lags- Fiscal
Impact Lag
Spending Multiplier

25. Fiscal Policy Complications
Lags
Ricardo-Barro Effect
Deficit spending leads public and businesses to save more for fear of future tax increases
Negates expansionary effect of gov’t spending
May cancel crowding out
Controlled by Politicians
Lag length
Policy reversals
Certain policies will NEVER be popular
Current structural deficit problem

26. Fiscal Policy Complications…
Uncoordinated State and Local Policies
Crowding Out

27. Three Tools of MP Reserve Requirement Discount rate
Open market operations
Main tool of MP
Buying/selling government securities on the open market

28. OMO and Interest Rates Fed target – the federal funds rate
This “drives” all other interest rates

30. Evaluation of MP 2 advantages over FP A. speed and flexibility
B. isolation from political pressure

31. Policy Lags- Monetary Policy
Inside
Recognition
Decision
Implementation
Outside
Impact

32. Policy Lags- Monetary Policy
Decision and Implementation Lags are relatively short
Meet every six weeks
or SOONER

33. Inside Lags Monetary- 12 member open market committee Quick decisions
Immediate implementation

34. Outside Lags and Complications
Monetary
Deposit multiplier
Banks holding excess reserves
Cyclical Asymmetry
Monetary policy may be better at controlling inflation than stimulating growth
Liquidity Trap
Increases in Money Supply leads to cash hoarding, not spending
Increases in money supply fail to decrease interest rates

35. Stabilization Policy may be Destabilizing if poorly timed

37. 2009- $100,000 to $250,000

39. Quantitative Easing

40. Quantitative Easing v. OMO
Size of purchases
Types of Purchases
Long term securities
Mortgage-backed securities

43. Phillips Curve
SR- inverse relationship between inflation and unemployment

44. Rightward Shift (think leftward SRAS)
Negative Supply Shock (increase in input prices)
Increased inflation expectations

45. Leftward Shift (think rightward SRAS)
Positive Supply Shock (decrease input prices)
Decreased inflation expectations

46. Stagflation and the Phillips Curve
70s seemed to discredit the Phillips Curve
Economist today see Phillips curve as a short run relationship

47. SRAS Shifts and Returns to LRE following expansionary policy

48. SRPC Shifts and Returns to LRE following expansionary policy

50. Phillips Curve
Expectation of Future Inflation is the most important determinant of future inflation
Rational Expectations Theory
Individuals use all available information in forming expectations about future inflation
Workers’ expecting increasing inflation demand higher wages thus causing greater inflation

51. Expectation of Inflation
Expect higher, shift SRPC right
Expect lower, shift SRPC left

52. Adam Smith- Classical View
“An Inquiry into the Nature and Causes of the Wealth of Nations”
aka “The Wealth of Nations”
“Invisible Hand”
Laissez-Faire
Government Stimulus only leads to inflation

57. Demand-side Economics John Maynard Keynes
Gov’t should target AD
during recession
Unemployment creates
slack in markets allowing
increases in AD without
inflation
Gov’t can smooth the business
cycle

58. WPA

59. WPA

63. Supply-side Economics
Aka “trickle-down”
Reaganomics

65. Supply-Side Economics
“trickle down”
Fiscal Policies that target SRAS and LRAS
Key Methods
Decrease business regulation
Decrease business marginal tax rates
Investment Incentives/Tax Credits

67. Rahn Curve (not in curriculum)