macro

Fiscal Policy Overview

• Types of Fiscal Policy:

  • Expansionary Fiscal Policy:

    • Aimed at increasing aggregate demand (AD).

    • Government actions include:

      • Increase in government spending.

      • Decrease in taxation.

      • Combined approach of spending increases and tax reductions.

  • Contractionary Fiscal Policy:

    • Aimed at decreasing aggregate demand to control inflation.

    • Measures include:

      • Decreasing government spending.

      • Increasing taxes.

      • Combined approach of spending decreases and tax increases.

Problems with Fiscal Policy

• Influence on Aggregate Demand:

  • Increases in AD may lead to inflation.

  • Decreases in AD may result in recession and cyclical unemployment.

• Decreases in Aggregate Supply (AS):

  • Can cause recession, unemployment, and inflation.

• Lag in Implementation:

• Recognition Lag: Time to recognize a problem is occurring (e.g., rising unemployment or inflation).

• Administration Lag: Time taken to make decisions regarding fiscal measures.

• Operational Lag: Delay from decision-making to implementation in the economy.

The Role of Taxes

• Tax Types:

  • Personal income tax, sales taxes (PST, GST), capital gains tax.

  • Taxes have a direct effect on disposable income.

• Recession Response:

  • Recommended to increase government spending and/or reduce taxes (expansionary approach).

• Economic Expansion Response:

  • Recommended to reduce government spending and/or increase taxes (contractionary approach).

Government Debt and Deficits

• Debt Management:

  • Government can 'go into debt' through borrowing to fund expenditures.

• Budget Surplus:

  • Occurs when government taxation exceeds spending.

• Budget Deficit:

  • Occurs when government expenditures surpass revenues.

• Public Debt:

  • Accumulation of all past deficits and surpluses.

Effects of Fiscal Policies

• Crowding-Out Effect:

  • Increased government borrowing can lead to higher interest rates.

  • Resulting in decreased private sector investment due to higher borrowing costs.

• Net Export Effect:

  • Increased government spending can strengthen the domestic currency, affecting exports negatively.

Long-term Considerations

• Discussions on balancing short-term fiscal policies with long-term growth are crucial.

  • MPC: Marginal propensity to consume can decrease, affecting multiplier effects of fiscal policy.

• Political influence and public trust affect the effectiveness of fiscal policy.

Monetary Policy Overview

• Monetary Policy Goals:

  • Achieve full employment and low inflation (target inflation rate: 2%).

• Policy Tools:

  • Adjusting the money supply (increase/decrease) through open-market operations (buying/selling government securities).

• Interest Rates:

  • Central bank sets overnight rate, influencing other interest rates.

Money Supply and Creation

• Definition of Money:

  • Money functions as a medium of exchange, unit of account, and store of value.

• Components:

  • M1: Cash and demand deposits.

  • M2: Includes less liquid forms of money (savings accounts, etc.).

Current Economic Environment and Policies

• Quantitative Easing:

  • Central banks purchase long-term securities to inject liquidity into the economy.

• Laffer Curve:

  • Illustrates relationship between tax rates and tax revenues, suggesting there is an optimal rate to maximize revenue without discouraging economic activity.

Trade and Exchange Rates

• International Trade Factors:

  • Comparative and absolute advantages influence trade decisions.

  • Trade agreements such as NAFTA and the role of organizations like the WTO are pivotal.

• Foreign Exchange Systems:

  • Floating, fixed, and managed exchange rate systems each have advantages based on market conditions.

Key Implications of Fiscal and Monetary Policies

• Trade-offs:

• Managing inflation versus unemployment requires different fiscal and monetary tools.

• Economic Balance:

• Achieving a balance between long-term growth and short-term stability is critical to avoid cyclical economic issues.