Econ 102 Ch14

Fiscal Policy

• Gov uses spending and tax policies to stabilize the economy

• minimize output fluctuation

• keep GDP close to potential output

Expansionary Fiscal Policy

• used when the econ is weak

  • increase spending/ lower taxes

  • AE shifts up

• output increases

Contractionary Fiscal Policy

• decreases spending/ raises taxes

• AE shifts down

• reduces output

Types of Gov spending to incrase GDP

• Direct: Gov Purchases

• Indirect: Transfer payments/ Tax Reductions

Automatic Stabilizers

• reduces the multiplier

Budget Balance

• S_public = T-TR-G

• Expansionary fiscal policies decrease the budget balance for that year,

  • make a budget surplus smaller or a budget deficit bigger.

• Contractionary fiscal policies increase the budget balance for that year,

  • making a budget surplus bigger or a budget deficit smaller

Cyclically Adjusted Budget Balance

• estimated to separate the effects of the business cycle from the effects of discretionary fiscal policy

Should the budget be balanced ?

• Economists believe the budget shouldn’t be run every year

  • undermine the role of taxes and transfers as automatic stabilizers

Fiscal Austerity

• Cuts government spending and raises taxes

• Reduces borrowing and signals credibility to lenders

• Contractionary fiscal policy

• IS curve shifts left

• Can worsen an already weak economy

• May undermine investor confidence instead of restoring it

Reasons not to worry about government debt

• Most of our government debt is money owed by Canadians to Canadians.

• Future generations can help repay the debt.

• It wouldn’t take a big adjustment to repay the debt.

• The government never really needs to repay the debt.

• The government has options that you don’t have

  • Raise taxes

  • Print money

Reasons to worry about government debt

• Slower economic growth: The government borrows funds that might otherwise be used to finance investments in productive capital.

• Harder to use fiscal policy in the future: Future fiscal choices are constrained because is harder to borrow.

• The risk of a crisis of confidence: A perceived risk of default could lead lenders to charge a higher interest rate, making it difficult/impossible to make loan repayments.

• A debt crisis (gov cant repay its loans) becomes more likely