Exam - fiscal policy

definiton of fiscal policy?

the use of taxes, government transfers, or government purchases of goods and services to shift the aggregate demand curve.

how does government purchases of good and services affect aggregate demand?

it affects AD directly

how does changes in taxes and government transfers affect AD?

Indirectly, as it changes households disposable income

how does expansionary fiscal policy affect AD?

shifts the AD curve to the right

where does contractionary fiscal policy shift the AD curve?

leftwards

when is the economy at risk of crowding out of private spending and private investment?

when at full employment, due to expansionary policy

why wont expansionary fiscal policy work on crowding out?

Because of Ricardian equivalence — that consumers will cut back spending today to offset expected future tax increases — appears to be untrue in practice. What is clearly true is that very active fiscal policy may make the economy less stable due to time lags in policy formulation and implementation

what effect does fiscal policy have on the economy?

multiplier effect, the size of which the economy depends on fiscal policy

what reduces the size of the multiplier?

a lump sum of taxes

what does expansionary fiscal policy lead to?

an increase in real GDP

what does contractionary fiscal policy lead to?

reduction in GDP

how does discretionary fiscal policy occur?

arises from deliberate actions by policy makers rather than from the business cycle

how do governments separate the effect of the business cycle from the effects of discretionary fiscal policy?

governments determine the cyclically adjusted budget balance, an estimate of the budget balance if the economy were at potential output.

how is the US government budget accounting calculated?

basis of fiscal years

what do larget budget deficits lead to?

public debt

what does public debt lead to?

• crowding out - leads to long-run economic growth

• financial pressure - economic and finance turmoil

what does a debt spiral do?

ill increase public debt if countries need to take on additional debt to pay past interest expenses.

what is a measure of fiscal health?

debt-GDP ratio

what are implicit liabilities?

a stable debt–GDP ratio may give a misleading sense of security.

definiton of social insurance?

used to describe government programs that are intended to protect families against economic hardship

Definition of automatic stabilisers?

Government spending and taxation rules that cause fiscal policy to be automatically expansionary when the economy contracts and automatically contractionary when the economy expands, without requiring any deliberate action by policy makers

Definition of the multiplier?

is the ratio of the change in real GDP caused by an autonomous change in aggregate spending to the size of that autonomous change. An increase in government purchases of goods and services is a prime example of such an autonomous increase in aggregate spending.

what is the formula for the multiplier?

1/(1 - MPC)

What does it mean if MPC is less that 0.5?

so that a smaller share of the initial transfer is spent, the multiplier on that transfer is less than 1.

what does it mean if the multiplier was larger than 1?

there is a larger share of the initial payment

definiton of sum-lump taxes?

In which the amount of tax a household owes is independent of its income. With lump-sum taxes there is no change in the multiplier.

defintion of debt-spiral?

And a government that borrows to pay interest on its outstanding debt may push itself even deeper into debt

debt-GDP ratio defintion?

The government’s debt as a percentage of GDP. We use this measure, rather than simply looking at the size of the debt, because GDP, which measures the size of the economy as a whole, is a good indicator of the potential taxes the government can collect

what happens if the government debt grows more slowly than GDP?

the burden of paying that debt is actually falling compared with the government’s potential tax revenue

defintion of the budget balance?

the difference between the government’s revenue, in the form of tax revenue, and its spending, both on goods and services and on government transfers, in a given year.

what is the equation for savings by government?

Government = T - G - TR

what does expansionary fiscal policy lead to?

• increased government purchases of goods and services

• higher government transfers

• lower taxes

• reduces the budget balance for that year

what does contractionary fiscal policy lead to?

• reduced government purchases on goods and services

• reduced government transfers

• increased tax

• increased the budget balance for that year

what is the relationship between the business cycle and the budget balance?

the budget moves into deficit when the economy experiences a recession

when the economy expands:

• budget deficit gets smaller

• turns into a surplus

defintion of cyclically adjusted budget balance?

an estimate of what the budget balance would be if real GDP were exactly equal to potential output. It takes into account the extra tax revenue the government would collect and the transfers it would save if a recessionary gap were eliminated — or the revenue the government would lose and the extra transfers it would make if an inflationary gap were eliminated.

why shouldnt the budget always be balanced?

undermine the role of taxes and transfers as automatic stabilisers

• for example, if there was a budget deficit, the government would respond with contractionary fiscal policy which would deepen the recession

what are the dangers by rising government debt?

• crowding out - when the economy is at full employment and the government borrow funds in the financial markets. Crowds out private investment, increasing interest rates and reducing the economy’s long-run rate of growth

• Financial Pressure and Default - causes bad shakes in public confidence in both the governemnt and the economy

what are examples of implicit liabilities?

• social security

• medicine pays most of older americans medical costs

• medicaid