1. Multiplier Effect, Policy Lag & Automatic Stabilizers
Fiscal Policy Wrap-up
Multiplier Effect, Policy Lag & Automatic Stabilizers

2. Policy Lags Fiscal policy has long “policy lags”
Taxes take time to cut
Spending takes time to occur
LRAS1
Price
Level
Real
GDP
SRAS1
AD1

3. End result of Fiscal Policy?
All make predicting the
final effect of FISCAL
POLICY Difficult!
Multiplier Effect
Crowding Out
Net Export Effect
Automatic Stabilizers
State & Local Tax Laws
LRAS1
Price
Level
Real
GDP
SRAS1
AD2
AD1

4. The CONFLICT between 2-theories:
Crowding Out
Multiplier
Effect
When Government Spending increases:
→ Multiplier argues for a larger increase in real GDP (AD)
→ Crowding out argues for a smaller increase in AD (real GDP)
We will ASSUME the multiplier always overpowers crowding out!

5. Net Export Effect Gov’t Borrows $ Real Interest Rates Rise Currency
Appreciates $
Export
Less
Explanation:
The US $ appreciates (worth more vs other currencies)
Goods become more expensive for foreigners
They buy less (NX ↓)

6. Automatic Stabilizers
Considered anything which automatically:
Increases deficit during recessionary periods
Increases surplus during inflationary periods
During
Recessions
Collect less taxes
Pay more unemployment & welfare benefits
During
Booms
Collect more taxes (progressive tax system)
Pay less unemployment & welfare benefits

7. State & Local Taxes
States & Local Governments are usually required to balance budget
Therefore, they may raise taxes when federal government cuts taxes
During recessions!
Offsets some of expansionary fiscal policy

8. Practice Free Response
LRAS1
Price
Level
Real
GDP
SRAS1
AD1