1. 14
Macroeconomic Policy

2. Fiscal Policy & Monetary policy
14-1
Fiscal Policy & Monetary policy

3. Main points Economic objective Discretionary Fiscal policy
Fiscal Policy Instruments
The Crowding Out Effect
Automatic stabilizers
Multiplier

4. Economic objective Full employment Price stabilization Economic growth
International payment balance

5. Stabilization policy
Stabilization policy describes both monetary and fiscal policy, the goals of which are to smooth out fluctuations in output and employment and to keep prices as stable as possible.

6. Government in the Economy
Tax rates are controlled by the government, but tax revenue depends on changes in household income and the size of corporate profits, which the government cannot control.
Discretionary fiscal policy refers to changes in taxes or spending that are the result of deliberate changes in government policy.

7. Fiscal Policy
Fiscal Policy -- the Federal government changing its government position (G , T) in order to stabilize the economy.
Fiscal Policy, by its nature, alters the Federal Budget. This chapter also examines the Federal Budget, what it’s made up of, and when budget deficits can be a problem in the economy.

8. Fiscal Policy Instruments
Government Revenues
Taxes
Public Bonds
Government Expenditures
Government purchase
Transfer payment

9. Government Expenditure
Social Security
Law and Order
Emergency Services
Health
Education
Defence
Foreign Aid
Environment
Agriculture
Industry
Transport
Regions
Culture, Media and Sport

10. The Federal Budget
Federal Budget (or Budget) = Tax Revenues - Government Expenditure (over a given period).
Federal Budget (or Budget) = Tax Revenues - (Government Purchases of Goods and Services + Transfer Payments + Interest on the National Debt).

11. Budget Definitions Budget < 0 -- Budget Deficit
Budget > 0 -- Budget Surplus
Budget = 0 -- Balanced Budget
Realistic Goal -- Balanced Budget when Y = YF.

12. The US Federal Budget: 2003 (Billions of Dollars)
Tax Revenues $1877.0
Government
Expenditure $2241.6
Federal Budget -$364.6
Source: Economic Indicators, September 2004.

13. Breakdown of Tax Revenues
Personal Income Taxes = $775.8
Corporate Profits Taxes = $191.4
Taxes on Production
and Imports (e.g. sales
and excise taxes) = $89.4
Contributions for
Social Insurance = $758.2
Other = $62.2

14. Breakdown of Government Expenditure
Purchases of
Goods and Services (G) = $658.6
Transfer Payments = $1322.5
Interest Payments = $214.1
Other = $46.4
Source: Economic Indicators, September 2004.

15. The Budget: In A Notation
Recall variable definitions:
-- T = net taxes
= tax revenues
- (transfer payments
+ interest on the
national debt)
-- G = government purchases of
goods and services

16. The Budget and Budget Position
Budget = T - G
Budget Position (or size of deficit)
= G - T

17. The National Debt
The National Debt -- The total accumulated stock of debt owed by the government to its lenders (holders of government bonds).
Expanded by budget deficits
reduced by budget surpluses.

18. National Debt -- Realistic Goal
Realistic Goal -- consider the
Debt-Income Ratio =
(National Debt)/(GDP).
For the US in 2003 =
($3913.6)/($ ) =
Information Source: Economic Indicators, September 2004.

19. The Income Tax and Automatic Stabilization
Automatic Stabilization -- due to the income tax system, tax revenues change in directions that help to stabilize the economy, without any change in the tax structure (I.e. fiscal policy).

20. Automatic Stabilizers
Automatic stabilizers smooth fluctuations in disposable income over the business cycle, thereby boosting aggregate demand during periods of recession and dampening aggregate demand during periods of expansion
Two good examples of automatic stabilizers
Progressive income tax
Unemployment compensation

21. Progressive Income Tax
The progressive income tax relieves some of the inflationary pressures that might otherwise arise when output increases above its potential during an economic expansion
Conversely, when the economy is in a recession, real GDP declines but taxes decline faster, so disposable income does not fall as much as real GDP  it cushions declines in disposable income, in consumption, and in aggregate demand

22. The Income Tax as an Automatic Stabilizer
Y* (maybe > YF)  Tax Revenues
helps to cool the economy
Y* (maybe < YF)  Tax Revenues
helps to stimulate the economy
Note -- all this takes place without any change in the tax structure, as prescribed by fiscal policy.

23. Unemployment Insurance-TR
During an economic expansion, unemployment insurance taxes flow from the income stream into the insurance fund, thereby moderating aggregate demand
During a recession, unemployment payments automatically flow from the insurance fund to those who have become unemployed  increasing disposable income and consumption

24. The Income Tax and the Federal Budget
Y*  Tax Revenues  T
 (T - G)
A strong and growing economy improves the budget.
Y*  Tax Revenues  T
 (T - G)
A weak economy generates a lower budget.

25. Strategy of Fiscal Policy
Expansionary policies seek to induce more purchasing of goods and services by increasing (G - T) -- i.e. G or T.
Contractionary policies seek to induce less purchasing of goods and services by decreasing (G - T) -- i.e. G or T.

26. Specific Types of Fiscal Policy
Change Government Purchases of Goods and Services (G)
-- Expansionary: G
-- Contractionary: G
Change Transfer Payments (Tr)
-- Expansionary: Tr
-- Contractionary: Tr

27. Tax Policy as Fiscal Policy
Change Marginal Tax Rates (t) Expansionary: t Contractionary: t
Change Tax Deductions Expansionary: Bigger Deductions
-- Contractionary: Smaller Deductions
Change Indirect Business Taxes (e.g. Sales or Excise Taxes)
-- Expansionary: Lower Taxes
-- Contractionary: Raise Taxes

28. Fiscal Policy in the AD-AS Model
Expansionary Fiscal Policy shifts the AD curve rightward, increases Y* and P*.
Contractionary Fiscal Policy shifts the AD curve leftward, decreases Y* and P*.
Note -- like monetary policy, fiscal policy is justified only from a short-run perspective.

29. Obstacles to Fiscal Policy Effectiveness
Difficulties in getting the proper policy passed through Congress and the president.
A tax cut that isn’t used for spending. AD curve does not shift rightward, no change in Y*.
Worries about the Federal Budget within a sluggish economy.

30. The Crowding Out Effect -- An Adverse “Side Effect”
The Crowding Out Effect -- Expansionary fiscal policy creates an increased demand for more borrowing by the government. This financing increases the demand for financial capital. As a result, long-term interest rates (r*) rise and Investment (I*) decreases.

31. The Crowding Out Effect -- Fiscal Policy Effectiveness
Crowding Out Effect -- makes fiscal policy less effective than would be otherwise.
Decrease in investment to some extent offsets rise in (G - T).
Smaller shift in AD curve than would be without the crowding out effect.

32. The Crowding Out Effect – Impeding Economic Growth
Crowding Out Effect  loss of Investment (I).
Decrease in Investment retards the buildup of the capital stock and possible implementation of new technology (i.e. Labor Productivity).
Smaller shifts in LAS curve, smaller increases in YF.

33. Ways to Avoid the Crowding Out Effect
Bottom line -- get the supply of financial capital to shift rightward at the same time as when expansionary fiscal policy occurs.
-- expansionary monetary policy
-- increased private saving
-- increase in foreign capital inflows

34. Distinctive Fiscal Policy Actions in the US
World War II
The Kennedy-Johnson Tax Cut of 1964
The Nixon Tax Increase of 1969
The Reagan Economic Recovery and Tax Act of 1981
Clinton Tax Increases of 1993
Bush Tax Cuts of ?

35. The Federal Government Surplus/Deficit as a Percentage of GDP, 1970 I-2000 IV

36. The Federal Government Debt as a Percentage of GDP, 1970 I-2000 IV
The percentage began to fall in the mid 1990s.

37. Fiscal Policy Since 1990
The average tax rate rose sharply under President Clinton and fell sharply under President Bush.
The deficit is a concern when tax rates are falling and spending is rising.

38. Federal Personal Income Taxes as a Percent of Taxable Income, 1990 I-2003 II

39. Federal Government Consumption Expenditures as a Percent of GDP, 1990 I-2003 II

40. Federal Transfer Payments and Grants-in-Aid as a Percent of GDP, 1990 I-2003 II

41. Federal Interest Payments as a Percent of GDP, 1990 I-2003 II

42. The Government Spending Multiplier
The government spending multiplier is the ratio of the change in the equilibrium level of output (GDP) to a change in government spending.
government spending multiplier
=1/(1-MPC)
边际消费倾向MPC=△C/△Y

43. The Government Spending Multiplier
Finding Equilibrium After a $50 Billion Government Spending Increase (All Figures in Billions of Dollars; G Has Increased From 100 in Table 25.1 to 150 Here)
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
OUTPUT (INCOME) Y
NET TAXES T
DISPOSABLE INCOME Yd / Y - T
CONSUMPTION SPENDING (C = Yd)
SAVING S (Yd – C)
PLANNED INVESTMENT SPENDING I
GOVERNMENT PURCHASES G
PLANNED AGGREGATE EXPENDITURE C + I + G
UNPLANNED INVENTORY CHANGE Y - (C + I + G)
ADJUSTMENT TO DISEQUILIBRIUM
300
100
200
250
- 50
150
500
- 200
Output8
400
650
- 150
700
600
550 50
800
- 100
900
950
1,100
1,000
850
Equilibrium
1,300
1,200
1,250
+ 50
Output9

44. The Tax Multiplier
A tax cut increases disposable income, which is likely to lead to added consumption spending. Income will increase by a multiple of the decrease in taxes.
However, a tax cut has no direct impact on spending. The tax multiplier for a change in taxes is smaller than the multiplier for a change in government spending.

45. The Tax Multiplier

46. Appendix B: The government spending and tax multipliers
The government spending and tax multipliers are derived algebraically as follows:
value of autonomous expenditures
multiplier

47. Appendix A: The government spending and tax multipliers
The government spending and tax multipliers when taxes are a function of income are derived as follows:
multiplier
value of autonomous expenditures

48. The Balanced-Budget Multiplier
The balanced-budget multiplier is the ratio of change in the equilibrium level of output to a change in government spending where the change in government spending is balanced by a change in taxes so as not to create any deficit.
However, a tax cut has no direct impact on spending. The tax multiplier for a change in taxes is smaller than the multiplier for a change in government spending.

49. Appendix A: The Balanced-Budget Multiplier
If we combine the effects of the government spending multiplier and the tax multiplier, we obtain:
Multiplier of government spending
Tax multiplier
and
then:
In words, a simultaneous increase in government spending by $1 and lump-sum taxes by $1 will increase equilibrium income by $1.

50. The Balanced-Budget Multiplier
Finding Equilibrium After a $200 Billion Balanced Budget Increase in G and T (All Figures in Billions of Dollars; G and T Have Increased From 100 in Table 25.1 to 300 Here)
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
OUTPUT (INCOME) Y
NET TAXES T
DISPOSABLE INCOME Yd / Y - T
CONSUMPTION SPENDING (C = Yd)
PLANNED INVESTMENT SPENDING I
GOVERNMENT PURCHASES G
PLANNED AGGREGATE EXPENDITURE C + I + G
UNPLANNED INVENTORY CHANGE Y - (C + I + G)
ADJUSTMENT TO DISEQUILIBRIUM
500
300
200
250
100
650
- 150
Output8
700
400
800
- 100
900
600
550
950
- 50
1,100
Equilibrium
1,300
1,000
850
1,250
+ 50
Output9
1,500
1,200
1,400
+ 100

51. Fiscal Policy Multipliers
Summary of Fiscal Policy Multipliers
POLICY STIMULUS
MULTIPLIER
FINAL IMPACT ON EQUILIBRIUM Y
Government- spending multiplier
Increase or decrease in the level of government purchases:
Tax multiplier
Increase or decrease in the level of net taxes:
Balanced-budget multiplier
Simultaneous balanced-budget increase or decrease in the level of government purchases and net taxes: 1

52. The Federal Budget
Federal Government Receipts and Expenditures, 2000 (Billions of Dollars)
AMOUNT
PERCENTAGE OF TOTAL
Receipts
Personal taxes
774.4
44.9
Corporate taxes
211.9
12.3
Indirect business taxes
91.3
5.3
Contributions for social insurance
645.9
37.5
Total
1,723.4
100.0
Current Expenditures
Consumption
463.8
26.5
Transfer payments
795.5
45.4
Grants-in-aid to state and local governments
224.2
12.8
Net interest payments
230.3
13.1
Net subsidies of government enterprises
38.4
2.2
1,752.2
Current Surplus (+) or deficit (-) (Receipts - Current Expenditures)
- 28.8
Source: U.S. Department of Commerce, Bureau of Economic Analysis.

54. The Tools of Monetary Policy
Open market operation
Reserve ratio
Discount rate

55. ★ Open market operation
The Tools of Monetary Policy
Easy Monetary Policy
Buying Securities from commercial banks
Bank gives up securities
FED pays bank
Bank have increased reserve
Buying securities from public
Public gives up securities
Public deposit notes in the bank

56. The Tools of Monetary Policy
Tight Monetary Policy
Selling Securities to commercial banks
FED gives up securities
Bank pays for securities
Bank have decreased reserve
Selling securities to public
Public pays by check from bank

57. The Tools of Monetary Policy
★ The Reserve Ratio
Raising The Reserve Ratio
Bank must hold more reserve
Bank decreasing lending
Monetary supply decreasing
Lowering The Reserve Ratio
Bank must hold less reserve
Bank increasing lending
Monetary supply increasing
★ Discount Rate

58. Easy Monetary Policy Tight Monetary Policy Buying securities
Lowering reserve ratio
Lowering discount rate
Tight Monetary Policy
Selling securities
Raising reserve ratio
Raising discount rate

59. The Federal reserve Assets Liabilities Securities
Loans to commercial bank
Liabilities
Reserves of the commercial banks
Treasury deposits
Federal reserve notes

60. Time Lags Regarding Monetary and Fiscal Policy
Time lags are delays in the economy’s response to stabilization policies.

61. Two Possible Time Paths for GDP
Path A is less stable—it varies more over time—than path B. Other things being equal, society prefers path B to path A.

62. Stabilization: “The Fool in the Shower”
Attempts to stabilize the economy can prove destabilizing because of time lags.
Milton Friedman likened these attempts to a “fool in the shower.” The government is constantly stimulating or contracting the economy at the wrong time.

63. Stabilization: “The Fool in the Shower”
An expansionary policy that should have begun to take effect at point A does not actually begin to have an impact until point D, when the economy is already on an upswing.

64. Stabilization: “The Fool in the Shower”
Hence, the policy pushes the economy to points F’ and G’ (instead of F and G). Income varies more widely than it would have if no policy had been implemented.

65. Recognition Lags
The recognition lag refers to the time it takes for policy makers to recognize the existence of a boom or a slump.

66. Implementation Lags
The implementation lag is the time it takes to put the desired policy into effect once economists and policy makers recognize that the economy is in a boom or a slump.
The implementation lag for monetary policy is generally much shorter than for fiscal policy.

67. Response Lags
The response lag is the time it takes for the economy to adjust to the new conditions after a new policy is implemented; the lag that occurs because of the operation of the economy itself.
The delay in the multiplier of government spending occurs because neither individuals nor firms revise their spending plans instantaneously.

68. Coordination between Monetary and Fiscal Policy
Cooperation
Consistency
Macroeconomic Policy
Clarity
Commitment
Economic Stability
Sustainable Growth

69. Questions What are targets of economic polices?
What are the instruments of fiscal policy?
How does the automatic stabilizer work?
Why the fiscal policy has the crowding out effect to private investment?
What are the multipliers of Government spending, taxes, balanced budget?