11 13 2014 1 Key steps in crowding out effect to lower investment and net exports Budget deficits will lead to higher interest rates which will reduce private spending and investment Higher interest rates will also increase the inflow of capital from abroad causing the dollar to appreciate and net exports to decline This then weakens the expansionary impact of a budget deficit Fiscal Policy Effective Stabilization Tool 11 13 2014 2 Other potential problems with fiscal policy other problems of using gov t taxation and expenditure policies for the purpose of achieving macroeconomic goals include To fund projects government will need to tax higher which reduces consumer spending and private savings and diminish employment in other sectors If project is financed by debt additional borrowing will lead to higher interest rates and future taxes to cover interest payments Also what really matters is the value of what is produced not the job itself Job creation is not valued if production is not valuable The Supply Side Effects of Fiscal Policy 11 13 2014 3 Main point stressed by supply side economists Changes in marginal tax rates the of an extra dollar of income earned that must be paid in taxes exert important effects on aggregate supply o Lower marginal tax rates means an individual gets to keep a larger share of their additional earnings which increases the incentive to earn and use resources efficiently increasing aggregate supply 4 Why high tax rates slow output growth 1 High marginal tax rates discourage work effort and productivity 2 High tax rates will adversely affect the rate of capital formation and the efficiency of its use When tax rates are high foreign investors will look for other places to put their and domestic investors will look for investment projects abroad where taxes are lower 3 High marginal tax rates encourages people to substitute less desired deductible goods for more desired deductible goods People in high tax brackets make tax deductible expenditures cheap Fiscal Policy and Recovery from Recessions 11 13 2014 5 Main arguments for using fiscal stimulus during a recession 1 Only some crowding out will occur so output will increase 2 The multiplier is large so an increase in G will have a big effect 3 Interest rates are weak incentives 6 Main arguments against using fiscal stimulation 1 More government spending now will lead to higher interest rates and taxes later 2 Stimulus spending will increase structural unemployment 3 Politically driven spending is inefficient
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