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12 C H A P T E R FISCAL POLICY
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Council of Economic Advisors (CEA)
LEGISLATIVE MANDATES Employment Act of 1946 Council of Economic Advisors (CEA) Joint Economic Committee (JEC)
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Expansionary Fiscal Policy
FISCAL POLICY AND THE AD-AS MODEL Two Options Discretionary Fiscal Policy Non-Discretionary Fiscal Policy Expansionary Fiscal Policy To Reduce Unemployment… Increase Government Spending Tax Reductions Combinations of the Two
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EXPANSIONARY FISCAL POLICY
the multiplier at work... $5 billion initial increase in spending AS Full $20 billion increase in aggregate demand P1 Price level AD2 AD1 $ $510 Real GDP (billions)
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FISCAL POLICY AND THE AD-AS MODEL Contractionary Fiscal Policy
To Reduce Inflation… Decrease Government Spending Tax Increases Combinations of the Two
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CONTRACTIONARY FISCAL POLICY
the multiplier at work... $5 billion initial decrease in spending AS P2 Full $20 billion decrease in aggregate demand Price level P1 AD3 AD4 $510 $522 Real GDP (billions)
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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?
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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
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Government Expenditures,
BUILT-IN STABILITY T Surplus Government Expenditures, G, and Tax Revenues, T G Deficit GDP1 GDP2 GDP3 Real Domestic Output, GDP
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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.
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FULL-EMPLOYMENT DEFICITS
No Change in Fiscal Policy T1 G, and Tax Revenues, T (billions) Government Expenditures, a b $500 475 450 425 G c GDP2 GDP1 (Year 2) (Year 1) Real Domestic Output, GDP
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FULL-EMPLOYMENT DEFICITS Discretionary Fiscal Policy Tax Decrease
G, and Tax Revenues, T (billions) Government Expenditures, d e $500 475 450 425 G f h g GDP4 GDP3 Year 4 Year 3 Real Domestic Output, GDP
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EVALUATING FISCAL POLICY
Full-Employment Budget Cyclical Deficit Recent U.S. Deficits & Surpluses Actual Deficit or Surplus Full-Employment Deficit or Surplus Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 -3.9% -4.5% -4.7% -2.9% -2.2% -1.4% -0.3% +0.8% +1.4% +2.4% +1.3% -1.5% -2.1% -2.4% -2.9% -2.8% -2.0% -1.3% -0.9% -0.4% +0.3% +1.1% +0.8% -1.5%
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GLOBAL PERSPECTIVE BUDGET DEFICITS OR SURPLUSES
AS A PERCENTAGE OF GDP, 2002 Italy Sweden Canada United Kingdom France United States Ireland Norway Japan Source: Organization for Economic Development and Cooperation
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PROBLEMS, CRITICISMS, AND COMPLICATIONS
Problems of Timing Recognition Lag Administrative Lag Operational Lag Political Considerations Political Business Cycles Offsetting State & Local Finance Crowding-Out Effect
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FISCAL POLICY, AGGREGATE SUPPLY AND INFLATION
AS Fiscal Policy: No Complications P1 Price level AD1 AD2 $ $510 Real GDP (billions)
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FISCAL POLICY, AGGREGATE SUPPLY AND INFLATION
AS Fiscal Policy: Showing Crowding-out Effect or Net Export Effect P1 Price level AD1 AD’2 AD2 $ $510 $504 Real GDP (billions)
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FISCAL POLICY IN THE OPEN ECONOMY
Shocks Originating from Abroad Net Export Effect
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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
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KEY TERMS 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 Copyright McGraw-Hill/Irwin, Inc., 2005 BACK END
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