Lecture 3_KeynesianCross

Taxes and Expenditures by Governments

Taxes: Governments in advanced economies collect 35-50% of National Income in taxes.
Expenditures: Taxes fund:
- Public Goods: Infrastructure, public order and safety, defense.
- Welfare State: Education, retirement benefits, health care, income support.
- Fiscal Stimulus: Used to stabilize business cycles.

Government Growth: Size of government relative to national income grows from less than 10% in less developed economies to 30-50% in advanced economies.
Government Size Stability: Remains stable in the richest countries after 1980.
Welfare State Expansion: Growth is primarily due to the expansion of:
- Public education.
- Public retirement benefits.
- Public health insurance.
- Income support programs.
Deficits in Rich Countries: Most wealthy nations run deficits and have significant public debt relative to GDP, especially highlighted during the Great Recession (2008-2010).

Entitlement (Mandatory) Spending: Funds for programs with automatically set funding levels based on eligible recipients (e.g., Medicare, Social Security).
Discretionary Spending: Optional spending determined by yearly appropriations at Congress's discretion (e.g., defense).
Expansion Against Recessions: To counter economic downturns, discretionary expenditures can be expanded.

Equilibrium Output: Given by the equation: (Y = \frac{1}{1-c_1}(c_0 + I + G - c_1T))
Scenarios:
1. Increase in government spending (G): ( \Delta Y / \Delta G )
2. Increase in taxes (T): ( \Delta Y / \Delta T )
3. Equal increase in government spending and taxes: ( \Delta Y / \Delta G) (comparing financing methods is crucial).

Multiplier Estimates: Research indicates that the fiscal multiplier from temporary, deficit-financed increases in government purchases is likely between 0.8 to 1.5, though it could range from 0.5 to 2.
Citation: Ramey, Valerie A. (2019) discusses the evidence from U.S. data post-financial crisis.
Multiplier Model: Observed that if (c_1 = 0.5), then ( \frac{1}{1-c_1} = 2).

Incorporating more variables into fiscal models affects the fiscal multiplier.
Future chapters will include discussions on:
- Money and interest rates.
- Monetary policy.
- Labor market dynamics, unemployment, and inflation.

In addition to discretionary fiscal policies, automatic stabilizers are built-in mechanisms of the tax-and-transfer system that help stabilize economic fluctuations (business cycles).
These policies operate based on rules and do not require specific legislative actions.

During recessions, national income (Y) decreases, leading to higher unemployment.
UI programs provide temporary financial assistance based on previous earnings, supporting consumers and reducing recession impacts on consumption.

Most countries implement a progressive income tax, where higher earnings lead to higher tax rates.
In economic expansions, as Y increases, tax contributions increase, rendering the economy more stable as consumption becomes less sensitive to income changes.

Implementing changes in government spending or taxes is often slow; legislative processes could take considerable time (e.g., 99 days for Korea's recent stimulus plan).
When interest rates are near zero, fiscal policy becomes vital due to limited options for central banks.

Upcoming lessons will focus on financial markets and the determination of interest rates under various monetary policy impacts.
Reference to Blanchard, Chapter 4, set for further exploration.