chapter 9 - fiscal policy · 500 475 450 425 g, t real gdp g t 1 t 2 gdp 3 (year 3) gdp 4 (year 4)...

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter 9 1

FISCAL POLICY

SLIDES PREPARED BY JUDITH SKUCE, GEORGIAN COLLEGE


In this chapter you will learn

9.1 What fiscal policy is and what it is used for

9.2 About the economy’s built-in stabilizers

9.3 The problems, criticisms, and complications of fiscal policy


Chapter 9 Topics

9.1 Fiscal Policy & the AD-AS Model

9.2 Built-In Stabilization

9.3 Problems, Criticisms & Complications


Fiscal Policy & the AD-AS Model

Since 1945, fiscal policy has been one of the government’s main stabilization policy tools

“active” if changes in government spending or taxes are at the option of the government

“non-discretionary” if independent of parliamentary action


used when recession occurs

Options:

Increased Government Spending

Tax Reductions

Combined Government Spending Increases & Tax Reductions

may create a budget deficit

Expansionary Fiscal Policy


AS

AD0

Pri

ce level

Real GDP (billions)

P0

GDPfGDP0recessionary

gap

Expansionary Fiscal PolicyFigure 9-1


AS

AD0

Pri

ce level

Real GDP (billions)

P0

GDPfGDP0

P1

AD1

Expansionary Fiscal PolicyFigure 9-1


used to combat demand-pull inflation

Options:

Decreased Government Spending

Increased Taxes

Combined Government Spending Decreases & Tax Increases

Contractionary Fiscal Policy

© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter 9 9Real GDP (billions)

AS

GDPf

AD3

P3

Pri

ce level

GDP3

inflationary

gap

Figure 9-2


© 2005 McGraw-Hill Ryerson Ltd. Macroeconomics, Chapter 9 10Real GDP (billions)

AS

AD3

P2

AD2

Pri

ce level


P3

Figure 9-2

GDPf


Policy Options: G or T?

depends on political views about size of government


Chapter 9 Topics





Built-In Stabilization

net tax revenues vary directly with GDP

– taxes rise when GDP rises, & vice versa

– transfer payments fall when GDP rises, & vice versa

leads to automatic stabilization over the business cycle


A structure of taxation & spending that:

– increases the deficit (reduces the surplus) during recession

– increases the surplus (reduces the deficit) during inflation

Automatic or Built-In Stabilizers


G,T T = Net Taxes

G (assumed

constant)

GDP2GDP1

T1

Figure 9-3

Deficit {

Built-In Stability


G,T T

G

GDP2 GDP3

SurplusT2

Figure 9-3

Built-In Stability


the stabilizers will automatically restrain economic expansion & cushion economic contraction

Economic Importance


The built-in stability depends on:

Tax Progressivity

– Progressive

– Proportional

– Regressive

The more progressive the tax system, the greater the economy’s built-in stability

Tax Progressivity


Evaluating Fiscal Policy

to evaluate fiscal policy stance, must

– adjust deficits & surpluses to eliminate automatic changes in tax revenues

– compare adjusted budgets to GDP


Cyclically Adjusted Budget

the cyclically adjusted budget shows what the budget balance would be if the economy were operating at full employment

500

real GDP

G, TT

G

GDP1

(year 1)

450

GDP2

(year 2)

full-employment

GDP

the cyclically

adjusted deficit is

zero in year 1 at

GDP1

it is also zero in

year 2 at GDP2

the deficit is a by-

product of the

recession


Figure 9-4

500

475

450

425

G, T

real GDP

G

T1

T2

GDP3

(year 3)

GDP4

(year 4)

the cyclically adjusted

deficit is zero in year 3

taxes are reduced

full-employment

GDP

Figure 9-4

$50 billion deficit

due to recession

$25 billion deficit due

to expansionary fiscal

policy

economy enters a

recession in year 4



Recent Canadian Fiscal Policy

neutral to mildly expansionary in the early 1990s

contractionary in later years

actual deficits have given way to actual surpluses


Federal Deficits (-) & Surpluses (+) as % of GDP

Year Actual deficit or surplus Cyclically adjusted deficit or surplus

1991 -5.4 -4.6

1992 -5.1 -3.9

1993 -5.5 -4.4

1994 -4.6 -4.2

1995 -3.9 -3.6

1996 -2.0 -1.4

1997 +0.7 +1.1

1998 +0.8 +1.1

1999 +0.8 +0.7

2000 +1.7 +1.5

2001 +1.0 +1.3

Table 9-1


Chapter 9 Topics





Problems of Timing– Recognition Lag

– Administration Lag

– Operational Lag

Political Considerations

Expectations of Reversals

Offsetting Provincial & Municipal Finance

Problems, Criticisms, & Complications


Crowding-Out Effect

expansionary fiscal policy

higher interest rates

reduction in interest-sensitive spending

may not be significant in a recession

fiscal policy can be accommodated by increases in money supply



some portion of the potential effect of expansionary fiscal policy may be dissipated in the form of inflation

illustrated…



AD0

AS

P0

Pri

ce level

Figure 9-5

Fiscal Policy

Real GDP (billions)

AD1

GDP0 GDPf

P1

GDP1


AD0

AS

P0

Pri

ce level

Figure 9-5

Fiscal Policy

Real GDP (billions)

AD1

GDP0 GDPf

P1

GDP1

price level rises

GDP increases

only to GDP1


Fiscal Policy in the Open Economy

Shocks Originating from Abroad

Net Export Effect…

recession

expansionary fiscal policy

higher domestic interest rates

increased foreign demand for C$

C$ appreciates

net exports decline

partial offset to expansionary fiscal policy

Table 9-1


inflation

contractionary fiscal policy

lower domestic interest rates

decreased foreign demand for C$

C$ depreciates

net exports increase

partial offset to contractionary fiscal policy

Table 9-1



Current Thinking on Fiscal Policy

most economists believe fiscal policy is a useful policy lever

– not for “fine-tuning”

– major discretionary fiscal policy should be held in reserve

– should be evaluated for impact on long-run productivity growth


Chapter 9 Topics




chapter 9 - fiscal policy · 500 475 450 425 g, t real gdp g t 1 t 2 gdp 3 (year 3) gdp 4 (year 4)...

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