Econ 102 1st Edition Lecture 14Outline of Last Lecture I. Fiscal PolicyII. Government Spending- EntitlementsIII. Reminder from Econ 101IV. Government: Short Term and Long-Term GoalsV. TaxationVI.The Role of Fiscal PolicyOutline of Current LectureI. Corporate Income TaxesII. Federal Deficits 1974-2013III. Automatic Stabilizers- Keynesian ViewIV.Are Deficits Bad?V. The Clinton, George W. Bush, and Obama AdministrationsVI.Financial Markets: Borrowing and LendingVII. Financial IntermediaryCurrent LectureI. Corporate Income Taxesa. US is very high compared to the rest of the worldb. Small share of GDP, large share of revenue collectionII. Federal Deficits 1974-2013These notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.a. got worse in 1980 recession, was up in 1998, then very deep in 2007/2008.b. Now our current federal government borrowing is approximately3% of GDP- * Know for the Exami. “Deficits and the Debt”1. 4.1% deficit in 2013 as a percentage of GDPc. moves over the business cycle in predictable waysIII. Automatic Stabilizers- Keynesian Viewa. Definition : Taxes and transfer payments that stabilize GDP with-out requiring policymakers to take explicit action.i. Makes the multiplier smaller, think of extreme case of 100% income taxb. The increased federal budget deficit works through three chan-nels:i. Increased transfer payments such as unemployment insur-ance, food stamps, and other welfare payments increase the income of some households, partly offsetting the fall inhousehold income.ii. Other households whose incomes are falling pay less in taxes, which partly offsets the decline in their household income. Because incomes do not fall as much as they would have in the absence of the deficit, consumption spending does not decline as much. 1. progressive income taxes, offsetsiii. Because the corporation tax depends on corporate profits and profits fall in a recession, taxes on businesses also fall. Lower corporate taxes help to prevent businessesfrom cutting spending as much as they would otherwise during a recession. 1. It is good to automatically cut the tax on business so they keep their workersIV.Are Deficits Bad?a. No: some kind of deficits are a good thing, stabilize the economyand make the recession smallerb. Yes: Crowding outV. The Clinton, George W. Bush, and Obama Administrationsa. At the beginning of his administration, President Bill Clinton pro-posed a “stimulus package” that would increase aggregate de-mand, but was defeated by Congress.b. Later, President Clinton, along with a Republican-controlled Con-gress, passed a major tax increase to balance the budget and brought the Federal budget into surplus.c. In 2001, President George W. Bush passed a 10-year tax cut planin part to stimulate the economy.d. After September 11, 2001, President Bush and Congress autho-rized new spending to stimulate the economy which had entered a recession.i. increased spending and cut taxes (less reserve) therefore were hit with a huge recessione. This was followed by other expansionary fiscal policyf. In 2009, President Obama and Congress enacted the largest stimulus package in U.S. history.g. The stimulus was controversial in both size and composition.VI.Financial Markets: Borrowing and Lendinga. Assume households can do 4 things with their savings:i. Put it in a bank1. Consumption goes down- you're saving, Investment goes up- firms are investing2. Intermediation processii. Loan directly to a firm or household1. “be the bank”2. EX: lend uncle to set up auto body shopiii. Buy bondsiv. Buy stocksb. Money sitting in a mason jar is losing purchasing poweri. Instead invest and earn interestii. Real Expected return from lending =a. {the nominal interest rate} - {the expected in-flation rate} - expected risk - transaction costs and taxesb. EX: Giving Gwen vs Classmate a loani. Gwen- 4% interest rate, know where shelives, has a PhDii. Classmate- 50% chance at paying me back or on time, therefore going to charge her twice as much, 8% interest so you get the same back as by lending to Gwena. process known as arbitrageb. in equilibrium, no arbitrage opportunities in financial markets2. lack of information makes you riskya. Young people pay a higher in-terest rateb. Middle age people pay a rela-tively low interest ratec. Elderly people pay higher be-cause different probability of them paying you backi. risk of deathiii. Arbitrage1. people with a lot of money move their money around all the time, every morning even!2. In equilibrium, there are no arbitrage opportunities in financial marketsa. Implies all equilibrium expected real rates of return are the same, so people generally refer to the “interest rate” as the return on invest-ments, which is the return on all types of sav-ings (net of risk of incomplete repayment/de-fault)b. A change in the return in one type of asset will affect the returns in other types of assets as people shift their savings around to get the highest real returnc. A change in the return in one type of asset will affect the returns in other types of assets as people shift their savings around to get the highest real returni. Arbitrage equalizes expected real rates of return (net of hidden costs, advan-tages such as risk, inflation, and liquid-ity)ii. Assets with higher likelihood of less-than-full repayment (known as default) must offer a higher rate of return to compensate for riskiii. Assets that are more liquid can of-fer lower rates of return as liquidity has value to saversd. Liquid: easily convertible into money on a shortnoticeVII. Financial Intermediarya. “between the savers and the borrowers”b. Financial intermediaries link households to financial markets, where they allocate savings to other households, to firms, and to governments.c. Financial intermediaries are considered part of the infrastruc-ture of a modern economyd. Financial crises were large (but not sole) contributors to both the Great Depression and the Great
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