ch 11 lo_fiscal_policy

7/26/2019 Ch 11 Lo_fiscal_policy

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Fiscal Policy

Del Mar College, John Daly2002 South-Western Publishing, A Division o !ho"son #earning


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$%&en'itures ( !a% )evenues

* e%&en'itures are greater than ta%

revenues, a bu'get 'eicit e%ists+

* ta% revenues are greater than

e%&en'itures, a bu'get sur&lus e%ists

* e%&en'itures euals ta% revenues, a

balance' bu'get e%ists+


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Fiscal Policy

)eers to changes in govern"ent

e%&en'itures an'or ta%es to achieve

&articular econo"ic goals, such as lo.une"&loy"ent, &rice stability, an'

econo"ic gro.th+

/overn"ent e%&en'itures is the su" ogovern"ent &urchases an' transer

&ay"ents+


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Fiscal Policy Deinitions

$%&ansionary iscal &olicyreers to increases ingovern"ent e%&en'itures

an'or 'ecreases in ta%esto achieve "acroecono"icgoals+

Contractionary iscal&olicy atte"&ts to'ecrease govern"ente%&en'itures an'orincreases in ta%es toachieve "acroecono"icgoals+


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Fiscal Policy Deinitions

Discretionary FiscalPolicy is 'eliberatechanges o govern"ent

e%&en'itures an'or ta%esto achieve &articularecono"ic goals+

Auto"atic Fiscal Policy ischanges in govern"ente%&en'itures an'or ta%esthat occur auto"atically.ithout a''itional1congressional action+


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!.o ey Assu"&tions

*n our 'iscussion o iscal &olicy, .e only

'eal .ith 'iscretionary iscal &olicy+

We assu"e that any change in govern"ent

s&en'ing is 'ue to a change in govern"ent

&urchases an' not to a change in transer

&ay"ents+


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De"an'-Si'e Fiscal Policy

A change in consu"&tion, invest"ent,

govern"ent &urchases, or net e%&orts can

change aggregate 'e"an' an' there oreshit the AD curve+

A change in ta%es can aect consu"&tion or

invest"ent or both an' there or can aectaggregate 'e"an'+


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Fiscal Policy3 A eynesian

Pers&ective


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Cro.'ing 4ut

)eers to a 'ecrease in &rivate e%&en'itures thatoccurs as a conseuence o increase' govern"ent

s&en'ing or the inancing nee's o a bu'get'eicit+

$cono"ists .ho believe the cro.'ing out&heno"enon e%ists argue that because o the 'irect

substitution o &ublic services or consu"ers&en'ing or because o higher interest rates,increases in govern"ent s&en'ing in'uceconsu"ers an' investors to s&en' less+


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Cro.'ing 4ut

Co"&lete Cro.'ing 4ut occurs .hen the 'ecreasein one or "ore co"&onents o &rivate s&en'ingco"&letely osets the increase in govern"ents&en'ing+

*nco"&lete Cro.'ing 4ut occurs .hen the'ecrease in one or "ore co"&onents o &rivates&en'ing only &artially osets the increase ingovern"ent s&en'ing+

Whether .e are 'ealing .ith co"&lete orinco"&lete cro.'ing out, the cro.'ing out eectsuggests that e%&ansionary iscal &olicy .ill haveless i"&act on aggregate 'e"an' an' )eal /DP

than eynesian theory &re'icts+


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eynesian !heory (

Cro.'ing 4ut

*n eynesian theory,e%&ansionary iscal &olicyshits the aggregate'e"an' curve to AD2an'

"oves the econo"y to&oint 2+

* there is no cro.'ing out,e%&ansionary iscal &olicyincreases )eal /DP an'lo.ers the une"&loy"entrate+

* there is inco"&letecro.'ing out,e%&ansionary iscal &olicyincreases )eal /DP an'

lo.ers the une"&loy"entrate, but not as "uch as inthe case o 5ero cro.'ingout+

* there is co"&letecro.'ing out,

e%&ansionary iscal &olicyhas no eect on the


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Cro.'ing 4ut, !he *nterest )ate,

An' Foreign #oanable Fun's Many econo"ists argue that oreigners in search

o the highest rates o return .ill hel& inance the'eicit by len'ing un's to the e'eral govern"entthrough their &urchases o 6+S+ !reasurysecurities+

7eore oreigners buy 6S !reas8ury securities,they "ust e%change their 'o"estic currency or6S 'ollars+

!he 'ollar .ill then a&&reciate in value relative toother currencies+

!his "a9es oreign goo's chea&er or A"ericans

an' A"erican goo's "ore e%&ensive ororei ners+


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Cro.'ing 4ut, !he *nterest )ate,

An' Foreign #oanable Fun's So"e o the cro.'ing

out o &rivate

e%&en'itures .illco"e in the or" o a

'ecrease in net

e%&orts+


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!he :e. Classical ;ie. o

Fiscal Policy3 Cro.'ing 4ut .ith :o*ncrease in *nterest )ates

*n'ivi'uals res&on' to e%&ansionary iscal &olicy, a larger'eicit, an' greater 'eicit-inancing reuire"ents by

thin9ing the ollo.ing


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!he :e. Classical ;ie. o

$%&ansionary Fiscal Policy As long as

e%&ansionary

iscal &olicy is

translate' into

higher uture

ta%es, there .ill

be no change in)eal /DP,

une"&loy"ent,

the &rice level,

or interest rates+


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#ags An' Fiscal Policy

>+ !he Data #ag

2+ !he Wait-An'-See #ag

?+ !he #egislative #ag

@+ !he !rans"ission #ag+ !he $ectiveness #ag

. So"e econo"ists argue that 'iscretionary iscal&olicy is not li9ely to have the i"&act on the

econo"y that &olicy"a9ers ho&e+ 7y the ti"ethe ull i"&act o the &olicy is elt, the econo"ic

&roble" it .as 'esigne' to solve "ay no longere%ist, "ay not e%ist to the 'egree it once 'i', or

it "ay have change' altogether+


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#ags An' Fiscal Policy

!he govern"enthas "ove' the

econo"y ro"

&oint > to &oint 2,an' not, as they

ha' ho&e', ro"

&oint > to &oint >=+


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De"an'-Si'e Fiscal Policy3 )eturn to the

eynesian Mo'el*t .oul' see" thatun'er the con'itionso no lags an' 5erocro.'ing out,

e%&ansionary iscal&olicy B eitherincreasinggovern"ent s&en'ing

or cutting ta%es B .ill.or9 at re"oving theecono"y ro" arecessionary ga&+

D ' Si' Fi l P li ) h


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eynesian Mo'el

* govern"ent9no.s the'ierence bet.een>an' :so that

it 9no.s ho."uch to change)eal /DP1 an' it9no.s the MPC,

then it can useiscal &olicy to getthe econo"y outo a recessionaryga& an' &ro'ucing

:atural )eal /DP+


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eynesian Mo'el * the govern"ent

'oesn=t 9no. the

actual MPC an' it'oesn=t 9no. theactual 'ierencebet.een >an'

:, then iscal

&olicy isn=t li9elyto .or9 as

inten'e'+


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!a% Cuts *nstea'3 Are !hings

Any Dierent An i"&ortant euation3

)eal /DP E -MPCm1 % !

A 'ollar s&en' by govern"ent is a 'ollars&ent a 'ollar ta% cut is a 'ollar &artlysave' an' &artly s&ent+ *n or'er to get the

sa"e change in )eal /DP, govern"ent hasto cut ta%es "ore than it has to raise&urchases+


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( A

Go. 'oes cro.'ing out uestion the

eectiveness o e%&ansionary 'e"an'-si'e

iscal &olicy Do bu'get 'eicits raise interest rates

Go. can an increase in the si5e o the

e'eral bu'get 'eicit aect the tra'e'eicit


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Su&&ly-Si'e Fiscal Policy

All other things hel' constant, lo.er "arginal ta%rates increase the incentive to engage in

&ro'uctive activities relative to leisure an' ta%avoi'ance activities+

/iven a cut in "arginal ta% rates t.o things .illha&&en3 *n'ivi'uals .ill have "ore 'is&osableinco"e the a"ount o "oney they can earn by.or9ing increases+

*n the analysis o "arginal ta% rates an' aggregatesu&&ly, .e i"&licitly assu"e that in the aggregate,a "arginal ta% rate cut increases .or9 activity+

!h P 'i t ' $ t P t


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!he Pre'icte' $ect o a Per"anent

Marginal !a% )ate Cut on Aggregate

Su&&ly


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!he #aer Curve3 !a% )ates an'

!a% )eturns

* inco"e ta% rates .ere lo.ere', .oul' itincrease or 'ecrease ta% revenue

!here are t.o ta% rates at .hich 5ero ta%revenues .ill be collecte' B 0 an' >00H+

An increase in ta% rates coul' cause ta%

revenues to increase+ A 'ecrease in ta% rates coul' cause ta%

revenues to increase+

!h # C ! ) t '


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!he #aer Curve3 !a% )ates an'

!a% )eturns


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!he #aer Curve3 *"&lications

We assu"e that as the ta% rate is re'uce', the ta%base e%&an's+ !he rationale is that in'ivi'uals .or9"ore, invest "ore, an' enter into "ore e%changes,

an' shelter less inco"e ro" ta%es an' lo.er ta%rates+

Go. "uch 'oes the ta% base e%&an' ollo.ing theta% rate re'uction

!a% revenues increase i a ta% re'uction is "a'e inthe 'o.n.ar'-slo&ing &ortion o the curve bet.een

&oints 7 an' C1 ta% revenues 'ecrease ollo.ing ata% rate re'uction in the u&.ar' slo&ing &ortion o

the curve bet.een &oints A an' 71+


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( A

/ive an arith"etical e%a"&le to illustrate

the 'ierence bet.een the "arginal an'

average ta% rates+ * inco"e ta% rates rise, .ill inco"e ta%

revenue rise as .ell

ch 11 lo_fiscal_policy

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