Chapter_13_Lecture_Presentation

Introduction to Macroeconomic Policy

• Fiscal Policy: Use of federal budget to achieve macroeconomic objectives.

• Focus of this section: Federal budget process, fiscal policy effects, and fiscal stimulus.

Federal Budget Overview

• Definition: Annual statement of government’s outlays (spending) and revenues (income).

• Purposes of the Federal Budget:

  1. Finance government activities.

  2. Achieve macroeconomic objectives such as full employment and economic growth.

Federal Budget Process

• Budget Making: Managed by the federal government and Parliament, including discussions by the Minister of Finance.

• Key Steps:

  • Consultations leading to budget proposal.

  • Parliamentary debate and enactment of necessary laws.

Highlights of the 2019 Federal Budget

• Revenues: $344 billion, sources include personal income taxes, corporate taxes, and indirect taxes.

• Outlays: $350 billion, primarily on transfer payments, goods/services, and debt interest.

• Deficit: $6 billion, indicating outlays exceeded revenues.

Budget Balance Concepts

• Budget Balance: Revenues minus outlays.

  • Surplus: Revenues > outlays.

  • Deficit: Revenues < outlays (2019 had a deficit of $6 billion).

  • Balanced Budget: Revenues = outlays.

Historical Budget Trends (1961 - 2019)

• Trends:

  • Outlays and revenues increased during the 1960s.

  • Late 1970s to 1980s experienced a large deficit as revenues fell.

  • Budget cuts in the 1990s eliminated deficits.

  • Deficit re-emerged during the 2008-2009 recession but stabilized post-2014.

Government Debt and its Implications

• Definition of Debt: Total amount borrowed by the government, accumulated through past deficits.

• Impact of debt: Growth slows if debt rises faster than GDP.

• Debt vs. Capital: Current government debt ($709 billion) exceeds value of public capital, indicating some funding goes to consumption rather than investment.

Supply-Side Effects of Fiscal Policy

• Impact on Employment and GDP:

  • Income taxes can lower potential GDP and aggregate supply by reducing the supply of labor due to diminished after-tax wages.

• Tax Wedge: Created when before-tax wages are higher than after-tax, affecting employment.

Influence of Taxes on Economic Activity

• Taxes Decrease Investment: Capital income taxes lower saving and investment.

• Laffer Curve: Relationship between tax rates and tax revenues; increasing rates beyond a certain point can reduce overall revenue.

Fiscal Stimulus Explained

• Definition: Use of fiscal policy to boost production and employment either through automatic changes or discretionary measures.

• Types of Fiscal Policy:

  1. Automatic Fiscal Policy: E.g., tax revenue adjustments based on GDP changes.

  2. Discretionary Fiscal Policy: Requires specific legislative action.

Automatic Stabilizers in the Economy

• Key Items:

  • Tax revenues decline in a recession, increasing deficits.

  • Transfer payments increase, providing additional economic support.

Cyclical vs. Structural Budget Balances

• Cyclical Budget Balance: Surplus or deficit based on real GDP fluctuations around potential GDP.

• Structural Budget Balance: Balance assuming the economy is at full employment.

2019 Canadian Structural Budget Balance

• 2019 federal deficit: $6 billion, but structural deficit potentially larger due to inflationary gaps.

Discretionary Fiscal Stimulus and Its Effects

• Stimulative Measures:

  • Focus on changing aggregate demand through government spending and tax policy.

  • Fiscal multipliers play a critical role in determining the effectiveness of fiscal stimulus.

• Government Expenditure Multiplier: Increase in government spending impacts overall GDP and growth positively.

• Tax Multiplier: Generally less effective than government spending in stimulating growth.

Challenges with Fiscal Policy Implementation

• Time Lags:

  • Recognition Lag: Delay in identifying the need for fiscal intervention.

  • Law-making Lag: Time taken for Parliament to approve changes.

  • Impact Lag: Delay from passing legislation to realizing effects on the economy.