1. Chapter Twenty Five The Government and Fiscal Policy

2. Government in the Economy 4 Fiscal Authority: Congress and the President and state and local officials 4 Responsibilities: –Set purchasing levels (G) –Set taxes (T) 4 We’ll assume that G and T are set at constant levels.

3. Disposable Income 4 Net Taxes: taxes minus transfers 4 Disposable income: income minus taxes Y d = Y - T

4. Aggregate Expenditures - with Government - AE = C + I + G Y d = Y - T Y d = C + S Y - T = C + S Y = C + S + T

5. The Model Economy 4 C = 500 + 0.75*(Income - Taxes) = 500 + 0.75*Y d 4 I = 50 4 G = 100 and T = 60.

6. Equilibrium 4 C + I + G = AE – 500 + 0.75*Income d + 50 + 100 = AE – 650 + 0.75*Income d = AE 4 AE = Income –650 + 0.75*Income d = Income –650 + 0.75*(Income - 60) = Income –605= (1 - 0.75)*Income –2420 = Income

7. Equilibrium 4 Income = 2420 – C = 500 + 0.75*(2420 - 60) = 2270 – S = 2420 - Taxes - C = 90 4 C + I + G = 2270 + 50 + 150 = 2420 = Y 4 S + Taxes = 150 = 100 + 50 = G + I

8. Equilibrium 4 Income = 2420 – C = 500 + 0.75*(2420 - 60) = 2270 – S = 2420 - Taxes - C = 90 4 C + I + G = 2270 + 50 + 150 = 2420 = Y 4 S + Taxes = 150 = 100 + 50 = G + I Note that S + T = G + I

9. Consumption=500+.75Y d Aggregate Planned Expenditures Income Savings + Taxes 500 550 Investment=$50 C C+I C+I+G Government=100 650 45 o

10. Income 500 C C+I+G = AE 650 Y=2240 GDP Aggregate Planned Expenditures 45 o

11. Income 500 550 C C+I C+I+G 650 Consumption Savings + Taxes 2240 Aggregate Planned Expenditures 45 o

12. Income 500 550 C C+I C+I+G 650 Consumption G + I 2240 Aggregate Planned Expenditures 45 o

13. AE = C + I + G Income (Y)2950 C = 500 + 0.8*Y G=50, T=0 I=40 Expenditures 45 o

14. C + I + G 1 Income (Y)2950 C = 500 + 0.8*Y G=60, T=0 I=40 Expenditures Suppose G increases by 10, taxes increase by 0. 3000 C + I + G 2 Y increases by 50 45 o

15. The Government Spending Multiplier   G = 10 and  Y = 50 4 Multiplier = 50/10 = 5 4 Multiplier = 1/(1-MPC) = 5

16. AE 2 = C + I + G Income (Y)2950 C = 500 + 0.8*Y G=50, T=10 I=40 Expenditures Suppose T increases by 10 2910 AE 1 = C + I + G Y decreases by 40

17. The Tax Multiplier   T = 10 and  Y = -40 4 Multiplier = -40/10 = -4 4 Multiplier = MPC/(1-MPC) = -4

18. AE 2 = C + I + G Income (Y)2950 C = 500 + 0.8*Y G=60, T=10 I=40 Expenditures Suppose G increases by 10, T increases by 10 2960 AE 1 = C + I + G increases Y increases by 10 45 o

19. Balanced Budget Multiplier   G = 10 and  Y = 10 1 4 Multiplier = 10/10 = 1

20. Multipliers == 1 1-MPC 1 1 Government spending multiplier Government spending multiplier Investment spending multiplier Investment spending multiplier Consumption spending multiplier Consumption spending multiplier ==

21. Multipliers 1 > MPC 1-MPC > 1 Government spending multiplier Government spending multiplier Tax decrease multiplier Tax decrease multiplier Balanced budget multiplier Balanced budget multiplier >>

22. The Federal Budget, Deficit, and Debt 4 Deficit 4 Deficit = G - Taxes –cyclical deficit –cyclical deficit: part of deficit which is due to the business cycle –structural deficit –structural deficit: part of deficit which exists even at full employment

23. Receipts and Outlays Federal Receipts and Outlays, 1939-1994 (Billions of Current Dollars) 0 200 400 600 800 1000 1200 1400 1600 19391947195519631971197919871994 Years Billions of Dollars Source: "Economic Report of the President, 1995", Table B-74, p. 435. Receipts Outlays

24. Federal Deficit Federal Surplus or Deficit, 1939-1994 (Billions of Current Dollars) -300 -250 -200 -150 -100 -50 0 50 19391943194719511955195919631967197119751979198319871991 Years Billions of Dollars Source: "Economic Report of the President, 1995", Table B-74, p. 435. 1994

25. Measuring the Deficit 4 Deficit = Expenditures - Taxes 4 As a percentage of GDP

26. Deficit as a Percentage of GDP

27. National Debt national debt The national debt refers to the total accumulation of past deficits.

28. The Economy’s Influence on the Deficit 4 Fiscal drag 4 Tax revenues that depend on the economy 4 Expenditures that depend on the economy 4 Automatic stabilizers

29. Government Deficits and Debt as a Percentage of nominal GDP, 1997, for selected countries

30. Review Terms & Concepts 4 Automatic stabilizers 4 Balanced budget multiplier 4 Budget deficit 4 Cyclical deficit 4 Discretionary fiscal policy 4 Disposable (after-tax) income 4 Federal budget 4 Federal debt 4 Federal deficit 4 Fiscal drag 4 Fiscal policy 4 Full-employment budget 4 Government spending multiplier

31. Review Terms & Concepts (cont.) 4 Monetary policy 4 Net exports 4 Net taxes 4 Privately held federal debt 4 Structural deficit 4 Tax multiplier