Fiscal policy


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Fiscal policy

  2. 2. LEGISLATIVE MANDATESEmployment Act of 1946Council of EconomicAdvisors (CEA)Joint EconomicCommittee (JEC)
  3. 3. FISCAL POLICY AND THE AD-AS MODELTwo Options• Discretionary Fiscal Policy• Non-Discretionary FiscalPolicyExpansionary Fiscal PolicyTo Reduce Unemployment…• Increase GovernmentSpending• Tax Reductions• Combinations of the Two
  4. 4. PricelevelReal GDP (billions)EXPANSIONARY FISCAL POLICYFull $20 billionincrease inaggregatedemandAD2 AD1$5 billion initialincrease in spendingthe multiplier at work...P1$490 $510AS
  5. 5. To Reduce Inflation…• Decrease GovernmentSpending• Tax Increases• Combinations of theTwoFISCAL POLICY AND THE AD-AS MODELContractionary Fiscal Policy
  6. 6. PricelevelReal GDP (billions)CONTRACTIONARY FISCAL POLICYFull $20 billiondecrease inaggregatedemandAD3 AD4$5 billion initialdecrease in spendingthe multiplier at work...P2$510 $522ASP1
  7. 7. FINANCING OF DEFICITS ANDDISPOSING OF SURPLUSES•Borrowing vs. New Money•Borrowing From The Public•Money Creation•Debt Retirement vs. Idle Surplus•Debt Reduction•ImpoundingWhich Policy Option?G or T?
  8. 8. BUILT-IN STABILITYNet tax revenues varydirectly with GDPTransfer payments behavethe opposite way as taxcollectionsAutomatic or Built-InStabilizersEconomic Importance
  9. 9. BUILT-IN STABILITYGDP1 GDP2 GDP3Real Domestic Output, GDPGovernmentExpenditures,G,andTaxRevenues,TDeficitSurplusTG
  10. 10. BUILT-IN STABILITYTax Progressivity• Progressive Tax System• Proportional Tax System• Regressive Tax SystemThe more progressive thetax system, the greater theeconomy’s built-in stability.
  11. 11. FULL-EMPLOYMENT DEFICITSGDP2 GDP1Real Domestic Output, GDPGovernmentExpenditures,G,andTaxRevenues,T(billions)GT1(Year 1)(Year 2)abc$500475450425No Change inFiscal Policy
  12. 12. FULL-EMPLOYMENT DEFICITSGDP4 GDP3Real Domestic Output, GDPGovernmentExpenditures,G,andTaxRevenues,T(billions)T2GT1Year 3Year 4def$500475450425DiscretionaryFiscal PolicyTax Decreasehg
  13. 13. EVALUATING FISCAL POLICYFull-Employment BudgetCyclical DeficitRecent U.S. Deficits & SurplusesYearActualDeficit orSurplusFull-EmploymentDeficit orSurplus1990199119921993199419951996199719981999200020012002-3.9%-4.5%-4.7%-3.9%-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%-2.1%-2.0%-1.3%-0.9%-0.4%+0.3%+1.1%+0.8%-1.5%
  14. 14. -6 -4 -2 0 2 4ItalySwedenCanadaUnited KingdomFranceUnited StatesIrelandNorwayJapanGLOBAL PERSPECTIVEBUDGET DEFICITS OR SURPLUSESAS A PERCENTAGE OF GDP, 2002Source: Organization for Economic Development and Cooperation
  15. 15. PROBLEMS, CRITICISMS,AND COMPLICATIONS•Problems of Timing•Recognition Lag•Administrative Lag•Operational Lag•Political Considerations•Political Business Cycles•Offsetting State & LocalFinance•Crowding-Out Effect
  16. 16. FISCAL POLICY, AGGREGATESUPPLY AND INFLATIONFiscal Policy:No ComplicationsPricelevelReal GDP (billions)AD1 AD2P1$490 $510AS
  17. 17. FISCAL POLICY, AGGREGATESUPPLY AND INFLATIONFiscal Policy:ShowingCrowding-out Effector Net ExportEffectPricelevelReal GDP (billions)AD1 AD2P1$490 $510ASAD’2$504
  18. 18. FISCAL POLICY IN THEOPEN ECONOMYShocks Originating from AbroadNet Export Effect