Concise Summary of Lecture on Macroeconomic Models and Fiscal Policy
Completion of Short-run Macroeconomic Model
- Analyzed short-run fluctuations in price-level and GDP.
- Aggregate demand shocks caused by events shifting aggregate expenditures.
- Aggregate supply shocks due to changes in production costs and technology.
- Short-run: Factor prices are generally constant unless impacted by policies.
- Intermediate period: Factor prices (wages, rents) adjust in response to output gaps.
- Long-run: Factor prices fully adjust; technology improves.
Output Gaps
- Output gap: Difference between actual output Y and potential output Y^*.
- Potential output represents maximum production capacity.
Factor Prices and Output Gaps
- Above potential output (Y > Y^*): Rising wages due to high demand for inputs, leading to inflationary pressure.
- Below potential output (Y < Y^*): Lower wages due to reduced demand for inputs, leading to recessionary pressure.
Economic Dynamics
- Positive Output Gap (Y > Y^*): Firms produce above capacity, causing wage increases and shifts in the aggregate supply curve to the left.
- Negative Output Gap (Y < Y^*): Firms produce below capacity, causing wage decreases and shifts in the aggregate supply curve to the right.
Downward Wage Stickiness
- Wage adjustments during slumps are slower; downward pressure on wages does not operate efficiently, prolonging high unemployment.
Government Intervention
- Governments can stimulate demand through fiscal policies (e.g., increased spending or tax reductions) to counteract negative output gaps.
- Automatic fiscal stabilizers help mitigate shocks without direct government action.
Limitations of Fiscal Policy
- Decision and execution lags delay fiscal actions, risking misalignment with economic conditions.
- Temporary tax changes can have uncertain impacts on consumer behavior.
- "Fine tuning" reflects the challenge of precisely adjusting expenditures or taxes to stabilize the economy.
Long-term Effects of Fiscal Policy
- Government spending on infrastructure can significantly affect potential output, enhancing long-run economic growth.
- Tax reductions could incentivize investment, possibly affecting the economy's capital stock and potential output.