Fiscal Policy and Economic Indicators

TARIFFS AND FISCAL POLICY

Introduction to Tariffs

  • Concept of tariffs illustrated through a hypothetical case:

    • If an engine is made in Canada, brakes in Mexico, and wheels in the USA, the impact of tariffs on the product is questioned.

  • Tariffs serve as a form of tax impacting the import portion of net exports (NX).

Fiscal Policy Overview

  • Definition of Fiscal Policy:

    • Conducted only by Congress and the Executive Branch.

    • Consists of changes in Federal taxes and purchases aimed at achieving macroeconomic policy objectives.

  • Examples of Fiscal Tools:

    • Countercyclical Policy: Adjusts fiscal spending based on economic cycles.

    • Automatically responds to economic changes (e.g., unemployment insurance).

    • Discretionary Policy: Involves deliberate actions for economic changes (e.g., tax cuts, infrastructure spending, COVID relief).

Government Purchases and Expenditures

  • Government Purchases:

    • Involves acquiring goods and services with a direct impact on the economy.

    • Formula: Y = C + I + G + NX

    • Where:

      • Y = National Income

      • C = Consumption

      • I = Investment

      • G = Government Spending

      • NX = Net Exports

  • Government Expenditures:

    • Broader category including transfer payments and grant distributions.

    • Key components:

    • Transfer Payments (47.9%): e.g., Social Security, Medicare.

    • Federal Purchases (22.5%): e.g., Defense Spending, National Parks.

    • Interest on National Debt (11.8%).

Types of Fiscal Policy

  • Countercyclical:

    • Automatically stabilizes the economy during recessionary or inflationary periods.

  • Discretionary:

    • Requires legislative action and discussion for implementation.

  • Automatic Stabilizers:

    • Federal spending/taxes that fluctuate with economic conditions, independent of legislative action.

Impact on Economic Conditions

  • Recession Scenario:

    • Objective: Restore economic equilibrium and employment.

    • Tools: Expansionary Fiscal Policy via increased government purchases or tax cuts.

    • Result: Shifts aggregate demand to the right, potentially increasing price levels.

  • Inflation Scenario:

    • Objective: Decrease inflation and restore price stability.

    • Tools: Contractionary Fiscal Policy via decreased government purchases or increased taxes.

    • Result: Shifts aggregate demand to the left, reducing price levels and inflation.

The Multiplier Effect

  • Definition:

    • The concept whereby an initial change in government spending leads to a series of subsequent increases in overall economic output.

    • Example: Increase in government defense spending influences contractors, which then affects their suppliers and further onto the economy.

  • Application:

    • Government Purchases Multiplier:

    • Measures the total impact of changes in government spending on overall GDP.

    • Formula: ext{Government Purchases Multiplier} = rac{ ext{Change in Real GDP}}{ ext{Change in Government Purchases}}

    • Government Taxes Multiplier:

    • Measures the total impact of changes in taxes on overall GDP.

    • Formula: ext{Tax Multiplier} = rac{ ext{Change in Real GDP}}{ ext{Change in Taxes}}

Conclusion and Recent Observations

  • Understanding fiscal policy requires recognizing the movement between purchases, taxation, and their effects on economic indicators.

  • Observations show significant impacts on GDP and employment from targeted fiscal strategies and wider macroeconomic conditions.