Chapter_6-_8_weeks-_Macro_-_Tagged

Fiscal Policy Overview

• Fiscal Policy: The use of taxes, government transfers, and government spending to influence the economy, particularly aggregate demand (AD).

Importance of Fiscal Policy

• Management of Economic Fluctuations: Fiscal policy is crucial for managing economic fluctuations, with specific tools for addressing recessionary and inflationary gaps.

• Expansionary vs. Contractionary Fiscal Policy:

  • Expansionary Fiscal Policy: Increases aggregate demand (AD).

    • Involves increasing government purchases, cutting taxes, and increasing government transfers.

  • Contractionary Fiscal Policy: Decreases aggregate demand (AD).

    • Involves reducing government purchases, increasing taxes, and reducing government transfers.

Key Definitions

• Government Transfers: Payments made by the government to households without receiving goods or services in return (e.g., Social Security, Medicare).

• Social Insurance Programs: Designed to protect families from economic hardship.

Government Spending and GDP

• GDP Formula: GDP = C (Consumption) + I (Investment) + G (Government spending) + X (Exports) - IM (Imports).

• Government Role: Controls G directly and influences C and I through taxes and transfers.

• Shifting AD Curve: Fiscal policy effectively shifts the AD curve by altering consumption and investment patterns.

The Multiplier Effect

• Definition: The concept that increased government spending creates additional income and output in the economy.

• Effects of New Spending: Each round of expenditure leads to further spending by consumers, which magnifies the initial impact on GDP.

• Marginal Propensity to Consume (MPC): The portion of additional income that households spend on consumption.

• Multiplier Calculation:

  • For government expenditure: Multiplier = 1/(1 - MPC)

  • Example: If MPC = 0.5, then multiplier = 2.

Budget Balance

• Definition: The difference between government revenues and expenditures.

  • Surplus: When revenue exceeds expenditures.

  • Deficit: When expenditures exceed revenue.

• Influence of Fiscal Policy:

  • Expansionary policies tend to decrease budget balance;

  • Contractionary policies tend to increase budget balance.

Fiscal Policy in Practice

• Expansionary Fiscal Policy for Recession:

  • Increases AD, potentially leading to increased deficits.

• Contractionary Fiscal Policy for Inflation:

  • Decreases AD, potentially leading to reduced deficits or increased surpluses.

Concerns with Public Debt

• Public Debt Issues: A high level of debt raises concerns about the government’s ability to manage fiscal stability and economic growth.

• Implicit Liabilities: Future obligations (e.g., pensions, health benefits) that can impact fiscal policy.

• Debt-to-GDP Ratios: Critical for assessing the sustainability of government debt levels across different countries.

Lag in Fiscal Policy

• Caution: Significant lags exist between recognizing the need for fiscal policy adjustments, planning, and implementing those changes.