Chapter 11 Fiscal Policy The Keynesian View and Historical Perspective fiscal policy changing taxes or government spending with the purpose of achieving macroeconomic goals conducted by Congress and the President before the Great Depression classical view was mainstream thought recovery from recessions would occur without fiscal policy and happen quickly the economy would self heal Keynes disagrees with classical economists o recourse prices are sticky downward unions large corporations o pessimism can get stuck in recession Keynesian equilibrium o increase in consumer spending firms sell more goods firms produce more goods as long as spending is strong boom continues o decrease in consumer spending firms sell fewer goods firms make fewer goods as long as spending remains weak recession continues o total spending total output o small changes have a BIG impact multiplier principle one individual s expenditures becomes the income of another small disruptions quickly become recessions indicates how much additional income will be created by 1 of additional spending o expenditure multiplier 1 1 MPC o assumes that all workers impacted by new spending were initially unemployed when in reality more spending just leads to higher prices if resources were already in use and that the multiplier will have its biggest impact if resources were unemployed marginal propensity to consume the proportion of additional income that households choose to spend on consumption paradox of thrift the idea that when many households try to increase saving actual saving may not increase o reality uncontrolled spending beyond your means isn t good more saving higher growth of GDP greater future GDP congress and the president should pursue countercyclical policy that attempts to move the economy in an opposite direction from the forces of the business cycle expansionary fiscal policy during a recession the government should cut taxes and or increase government spending this will run a budget deficit this will stimulate AD and shift it right restrictive fiscal policy during a boom the government should increase taxes and or cut government spring this will run a budget surplus this will dampen AD and shift it left policy lags political process moves slowly policy takes time to impact economy 6 12 months o it s difficult to predict future economic conditions o incorrect policy timing would create economic instability not fix it automatic stabilizers tend to lead to a budget deficit during a recession and a surplus during a boom do not require change in policy ex unemployment compensation corporate profit tax and progressive income tax Chapter 12 Fiscal Policy Incentives and Secondary Effects expansionary fiscal policy during a recession government cut taxes and or increase spending running budget deficit Keynes believes this will stimulate AD and shift it right other economists disagree crowding out a reduction in private spending as a result of budget deficits financed by borrowing in the private loanable funds market o expansionary fiscal policy financed by deficit borrowing o this implies that expansionary fiscal policy won t restore the economy to full employment during a recession o when interest rates rise private investment is crowded out falling in output of capital goods reduces will lead to higher interest rates long run economic growth crowding in implies that restrictive fiscal policy won t dampen inflation during an expansion restrictive fiscal policy and budget surpluses lower interest rates new classical economics believe the economy tends toward full employment government borrowing shifts timing of taxes but not magnitude interest payments expansionary fiscal policy financed by budget deficit no change in interest rates o in the loanable funds market demand increases because of higher government borrowing and supply o Ricardian equivalence the theory that raising taxes and running a budget deficit are essentially equivalent increases because of more private saving and will have no impact on consumption or AD NOTE both the crowing out and new classical models indicate that secondary effects negate the stimulating impacts of expansionary fiscal policy Discretionary fiscal policy taxes than surpluses o no politician wants to be a Debby Downer spend money to directly benefit constituents reluctant to raise o countercyclical policy is not popular budget deficits are more attractive budget deficits are more common o economists agree timing of fiscal policy is difficult automatic stabilizers help mitigate fluctuations budget deficits have secondary impacts Supply Side Economics lower tax rates increase the incentive to work and invest investment causes capital formation increases long run aggregate supply higher tax rates reduce incentive to be productive decrease investment encourage purchases of fancy tax deductible stuff Will fiscal stimulus speed recovery Keynesians YES Tax cutting vs Spending increases Gov t spening increase is better than tax cuts tax cuts can be saved or spent abroad Non Keynesians NO more government debt means higher interest rates and less economic growth increased gov t spending will be politically motivated and more politically directed spending leads to less wealth creating production Tax cuts are better than gov t spending tax cuts can be implemented quickly and tax cuts are easier to reverse Chapter 13 Money and the Banking System medium of exchange as asset that is used to buy and sell goods or services money is a medium of exchange store of value item people can use to transfer purchasing power from the present to the future money is a store of value inflation causes money to cease being a store of value liquid asset can be easily converted into money without loss of value unit of account the unit of measurement people use to post prices and keep track of revenues and costs money is a unit of account fiat money money that has neither intrinsic value nor the backing of a commodity with intrinsic value has value because we trust that it is valuable and because it is scarce U S currency is fiat money M1 money supply the sum of currency checkable deposits travelers checks o demand deposits noninterest earning checking deposits that depositors can access by writing a check or using debit card mutual fund shares M2 money supply includes M1 plus savings deposits time deposits less than 100 000 and money market o money market and mutual funds interest earning accounts that pol
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