Chapter 11: Fiscal Policy

Fiscal Policy

changes in government spending and taxation

What determines if something is fiscal policy

if it achieves macroeconomic objectives

Who does fiscal policy refer to

Actions of the federal government and not state and local government

automatic stabilizers

government spending and taxation that automatically increases or decreases as a the the business cycle goes through different phases. It happens according to existing laws without the congress and president making new laws

examples of automatic stabilizers government spending

• unemployment insurance payments increase during recessions and decrease during expansions

• Taxes automatically increase during expansions and decrease during recessions

discretionary fiscal policy

require government to take action to change spending levels and or taxation

example of discretionary policy

the American recovery and reinvestment act, tax cut and Jobs act, and fiscal response to Covid 19 (all new policies)

government purchases

spending on goods and service by the government

• ex: government pays public service employees, procures military equipment, buys vehicles, computers, etc

government expenditure

includes government purchases and other spending like..

• interest on national debt, grants to state and local governments, and transfer payments

interest on national debt

paid to holders of t bonds (usd to finance budget deficits)

grants to state and local governments

Used to fund government activities at the state level (schools/environmental regulations)

transfer payments

include social security payments, unemployment insurance payments, and Medicare

how does the federal government raise revenue

income taxes, payroll taxes for social security, and corporate income taxes

• other taxes: federal excise taxes taxes on specific goods such as cigarettes and gasoline)

• Tariffs paid on imports

Fiscal policy relation to business cycle

Can be used to offset the effects of the business cycle

Countercyclical policies

short-run policies that offset the effects of the business cycle

• fiscal policies are counter cyclical

during a recession …

• increase government purchases

• Decrease taxes

  • All increase AD

During an expansion

• decrease in government purchases

• Increase in taxes

  • All decreases AD, GDP, and price level

Expansionary fiscal policy

involves increasing government purchases and decreasing taxes

• ↑ govt. purchases — ↑ AD

• ↓ Personal taxes — ↑ disposable income and consumption

• ↓ Business taxes — ↑ investment

  • The goal is to increase real gdp and get the economy out of recession

contractionary fiscal policy

involves decreasing government purchases and increasing taxes

• ↓ govt. purchases — ↓ AD

• ↑ Personal taxes — ↓ disposable income and consumption

• ↑ Business taxes — ↓ investment

  • The goal is to keep economy from inflation

Recession summary

• type of policy: expansionary

• Actions: increase government purchase, cut taxes

• Result: real gdp increases and price level increases

Expansion summary

• type of policy: contractionary

• Actions: decrease government purchases and increase taxes

• Result: real gdp decreases and price level decreases

autonomous expenditure

Government spending that is planned or fixed regardless of the current level of national income or output

Induced expenditure

spending that rises or falls automatically with changes in national income

the multiplier effect

the process by which an autonomous expenditure leads to a larger increase in GDP

Government purchases multiplier

△Y/△G (change in equilibrium GDP/change in government purchases)

the tax multiplier

△Y/△T (change in real gdp/change in taxes)’

• notes: TAX MULTIPLIER IS ALWAYS NEGATIVE

Equilibrium condition/consumption function

y = C₀ + MPC(Y - T₀) + I₀ + G₀

government spending multiplier (with mpc)

1/1-MPC — USING C₀ + MPC(Y - T)

tax multiplier using MPC

-MPC/1-MPC

limitations to using fiscal policy

• Data and recognition lag

• Legislative lag

• Crowding out of private spending

  • Public spending may reduce private spending because government spending causes private investment spending to decrease and interest rates to increase

Budget balance

the difference between government expenditures and its revenues

expenditures > revenue

budget deficit

expenditures < revenue

Budget surplus

expenditures = revenue

Budget balance