Chapter 9 The Government and Fiscal Policy Keynesians believe the Macroeconomy is likely to fluctuate too much if left on its own and that the government should smooth out fluctuations in the business cycle Others believe that government spending is incapable of stabilizing the economy Government affects Macroeconomy though fiscal policy and monetary policy Fiscal policy spending and taxing behavior divided into 3 categories policies concerning government purchases of goods and services policies concerning taxes policies concerning transfer payments Monetary policy refers to the behavior of the nation s central bank Federal Reserve concerning the nation s money supply Government in the Economy We need to distinguish between variables that a gov controls directly and variables that are a consequence of gov decisions combined with the state of the economy tax rates controlled by the gov but tax revenue is not under COMPLETE government control other factors play a role Discretionary fiscal policy changes in taxes or spending that are the result of deliberate changes in government policy Net taxes T taxes paid by firms and households to the government minus transfer payments made to households by the government collection of taxes and payment of transfer payments Disposable after tax income total income minus net taxes Y T Yd disposable income must end up as consumption C or savings S therefore Yd C S identity always true Because disposable income is aggregate income Y minus net taxes T we can write Y T C S add T to both sides Y C S T identity o Aggregate income cut into 3 pieces government takes a slice net taxes households divide into consumption and savings Planned aggregate expenditure AE sum of the consumption spending of households C planned investment by business firms I and government purchases of goods and services G AE C I G identity Budget deficit the different between what a government spends and what it collects in taxes in a given period G T Consumption function should use disposable income not before tax income so change C a bYd to C a b Y T Equilibrium Y C I G If output Y exceeds planned aggregate expenditure C I G there will be an unplanned increase in inventories If leakages S T equal planned injections I G there is equilibrium o Saving investment approach to equilibrium S T I G Fiscal Policy at Work Multiplier Effects Government Spending Multiplier o Effects of higher government spending while taxes remain constant o How much of an increase in spending would be required to generate an increase in the equilibrium level of output that would reduce unemployment o An increase in gov spending has the same impact on the equilibrium level of output and income as an increase in planned investment o Government spending multiplier 1 MPS o Government spending multiplier the ratio of the change in the equilibrium level of output to a change in the government spending o Reduce unemployment while holding gov spending constant so cut Tax Multiplier taxes o Cut taxes more disposable income increase in consumption planned aggregate expenditure increases inventories lower than planned rise in output more workers employed more income generation more consumption o The multiplier for a change in taxes is not the same as the multiplier for a change in gov spending When gov increases spending there is an immediate and direct impact on the economy s total spending When taxes are cut there is no direct impact on spending Final effect on equilibrium is smaller for tax cut than for gov o Tax multiplier the ratio of change in the equilibrium level of output to a change in taxes o Tax multiplier MPC MPS Negative bc a tax cut will cause an increase in consumption and a tax increase will cause a reduction in consumption Balanced Budget Multiplier o Gov spends x more and taxes rise by the same amount two things happen o 1 Government spending rises by x direct immediate positive o 2 Government collects x in taxes tax increase has a negative impact on overall spending in the economy o Balanced budget multiplier 1 o Balanced budget multiplier the ratio of change in the equilibrium level of output to a change in government spending where the change in gov spending is balanced by a change in taxes so as not to create any deficit the change in Y resulting from the change in G and the equal change in T are exactly the same size as the initial change in G or T The Federal Budget Federal budget the budget of the federal gov details all the things the gov plans to spend money on and all the sources of gov revenues for the coming year It is really 3 different budgets o Political document that dispenses favors to certain groups regions and places burdens taxes on others o Reflection of foals that the gov wants to achieve o Embodiment of some beliefs about how the gov should manage the Macroeconomy Federal surplus or deficit federal gov receipts minus expenditures Average tax rate rose sharply under Clinton fell sharply under Bush and remained low under Obama 3 most important spending variables of the gov consumption expenditures transfer payments grants in aid to state local govs Consumption expenditures as a of GDP generally fell during Clinton generally rose during Bush and continued to rise during Obama Transfer payments as a of GDP generally rose during the Bush administration and remained high during Obama flat slightly falling during Clinton During Clinton the federal budget moved from substantial deficit to noticeable surplus during Bush that surplus turned into a substantial deficit deficit rose sharply during Obama When the gov borrows it sells gov securities to the public it issues paper promising to pay certain amounts with interest in the future this borrowing increase the federal debt the total amount owed by the federal gov Privately held federal debt the privately held non government owned debt of the US government The Economy s Influence on the Government Budget Automatic stabilizers and destabilizers effects that the gov has no direct control over Tax revenues depend on the state of the economy when an economy goes into a recession tax revenues will fall even if the rates remain constant If the economy declines unemployment increases increase in unemployment benefits Automatic stabilizers revenue and expenditure items in the federal budget that automatically change with the state of the economy in such a way as to stabilize GDP Inflation often picks up in expansion Automatic destabilizer
View Full Document
Unlocking...