Unit 5 Notes Topic 5.1 Implications of Fiscal Policy 1. Would it be a good idea for the G to be required to balance their budget annually? 2. How does Fiscal Policy (G, taxes, transfers) affect national debt? Review:- Positive- how things are, no judgment - Normative- putting judgment on ito We are looking @ debt w/ positive viewo Most of the time, G looks @ debt w/ normative view - Budget Balance = G tax Revenue – G spending o Budget surplus- tax > spending (savings)  S = I o Budget deficit- tax < spending - S (by G) = Taxes – G spending – transfers - Full Employment- no cyclical employment, utilizing all resources to max Assumptions:1. HH budgets are different from G budgets: G can get out of debt  borrow, sell assets, raise taxes2. Business Cycle and Cyclically Adjusted Budget Balancea. Budget deficit almost always:i. Rises when UR risesii. Falls when UR falls **not just b/c of fiscal policy  could be an automatic stabilizer, result of the business cycle iii. Ex: during a recession- decline in income and profits  tax revenue goes down  UR rises  transfers increase 1. No fiscal policy involved, just happened iv. Ex: during an inflation- increase in income and profits  tax revenue goes up  UR falls  transfers decrease 1. No fiscal policy, happens b/c business cycle b. How fiscal policy actually affects debt and budgets and deficit (business cycle is variable),need to get rid of business cycle and just look at fiscal policy c. Cyclically adjusted budget balance- an estimate of what the budget balance WOULD be if real GDP was exactly equal to potential output (Yp)  takes into account: i. Extra tax revenue G would collectii. Transfers G would save iii. Revenue G would loseiv. And extra transfers G wouldn’t make Case#__________ Type of Output Gap or Equilibrium ____________________________Starting Point- Show what the current economy looks like on a graph below:Pivotal Event- Who will attempt to put the economy back in LR Equilibrium? Government through Fiscal Policy/ Fed through Monetary Policy/ Hands off- AutomaticStabilizersWhich curve do they want to affect and in which direction?_________________________Does this policy have a name?________________________________________________What tools does this institution have at its disposal? (Both direct and indirect, if any?)1)2)3)How do these tools work?Initial and SR Effects of the Event: Show how these actions affect equilibrium on the graph above. Explain. Secondary and LR Effects of the Event: Explain the secondary effects of this these actions. If possible, add them to your graph.Case#__________ Type of Output Gap or Equilibrium ____________________________Starting Point- Show what the current economy looks like on a graph below:Pivotal Event- Who will attempt to put the economy back in LR Equilibrium? Government through Fiscal Policy/ Fed through Monetary Policy/ Hands off- AutomaticStabilizersWhich curve do they want to affect and in which direction?_________________________Does this policy have a name?________________________________________________What tools does this institution have at its disposal? (Both direct and indirect, if any?)1)2)3)How do these tools work?Initial and SR Effects of the Event: Show how these actions affect equilibrium on the graph above. Explain. Secondary and LR Effects of the Event: Explain the secondary effects of this these actions. If possible, add them to your graph. Answers to Question 1 1. Would it be a good idea for the G to be required to balance their Budget annually? - Even though it looks good on paper fixing (easy), it’s way harder to gauge exactly what to do to get it right (potential output) o 3 lags w/ fiscal policy: recognizing, decision, implementation - Risk of making deficit even larger in recessionary gap, OR inflation higher in an inflationary gap  sometimes not worth the results **Changes in BB don’t always perfectly reflect changes in Fiscal Policy for 2 reasons:Y = C + I + G + (X – IM)1. AD curve doesn’t shift in same way w/ change in C or change in G a. When G increases/decreases they know FORSURE how it’s going to moveb. When G increases/decreases C by changing taxes or transfers, don’t know WHAT people will do w/ the money 2. Business cycle- automatic stabilizers are still occurring Answer to Question 2 - How does Fiscal Policy affect debt in LR? National Debt  the accumulation of all past deficits – all past surpluses Concerns Options1. G borrows $  investors aren’t investing  G is “crowding out” other investors (on capital)  PPF never moves out (never economic growth) 1. borrowing 2. future obligations (credibility, interest on debt) 2. Fed makes more $ 3. increase taxes or decrease G or decrease transfers  best option out of the 3 Debt- GDP Ratio- the gov.’s debt as a percentage of real GDP used to assess the ability of gov.’s to pay their debt (use calculation to see if gov can pay back their debt) Implicit liabilities- something that gov. owes that they are going to have to pay for in the future Topic 5.2 Monetary Policy and the Interest Rate 1. What is the role of monetary policy in stabilizing the economy? 2. Is the MS the only thing the Fed cares about? Review- UR increasing filling in a recessionary gap Case#__________ Type of Output Gap or Equilibrium ____________________________Starting Point- Show what the current economy looks like on a graph below:Pivotal Event- Who will attempt to put the economy back in LR Equilibrium? Government through Fiscal Policy/ Fed through Monetary Policy/ Hands off- Automatic StabilizersWhich curve do they want to affect and in which direction?_________________________Initial and SR Effects of the Event: Show how these actions affect equilibrium on the graph above. Explain. Secondary and LR Effects of the Event: Explain the secondary effects of this these actions. If possible, add them to your graph. Case#__________ Type of Output Gap or Equilibrium ____________________________Starting Point- Show what the current economy looks like on a graph below:Pivotal Event- Who will attempt to put the economy back in LR Equilibrium?Government through Fiscal Policy/ Fed through Monetary Policy/ Hands off- AutomaticStabilizersWhich curve do they want to affect and in which direction?_________________________Initial and SR Effects of the Event: Show how these actions affect equilibrium on the graph above. Explain. Secondary and LR Effects of the