Download krugman ir macro module 30(66).indd

Module
30(66)
Fiscal Policy Basics
Module Objectives
What students will learn:
• What fiscal policy is
• Why fiscal policy is an important tool for managing economic fluctuations
• Which policies constitute expansionary fiscal policy and which constitute contractionary fiscal policy
Module Outline
Opening Example: The opening story discusses the controversy surrounding the
American Recovery and Reinvestment Act of 2009. The controversy concerns whether
the amount of stimulus was too big, too small, or just right.
I.What is Fiscal Policy?
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A.Sources of government tax revenue in the United States in 2007 included:
1. personal income taxes: 37%.
2. social insurance taxes: 25%.
3. corporate profit taxes: 11%.
4. other taxes mainly collected at the state and local level: 27%.
B.Total government spending in the United States in 2007 included:
1. education: 17%.
2. Medicare and Medicaid: 20%.
3. national defense: 15%.
4. Social Security: 16%.
5. other goods and services: 25%.
6. other government transfers: 8%.
C.Definition: Social insurance programs are government programs intended to
protect families against economic hardship.
1. Social Security provides income to older Americans.
2. Medicare covers much of the cost of health care for Americans over
age 65.
3. Medicaid covers much of the cost of health care for Americans with low
incomes.
4. Unemployment insurance provides payments to unemployed workers.
5. Food stamps provide food to low-income families
Module 30(66)
fiscal policy basics
D.The government directly controls government spending (G), indirectly influences consumer spending (C) with transfer payments and taxes, and sometimes influences investment spending (I) through its tax policies.
E. Expansionary fiscal policy
1. Expansionary fiscal policies include:
a.increases in government purchases of goods and services.
b.decreases in taxes.
c.increases in government transfer payments.
2. Expansionary fiscal policies increase aggregate demand and thus shift the
aggregate demand curve to the right.
F. Contractionary fiscal policy
1. Contractionary fiscal policies include:
a.decreases in government purchase of goods and services.
b.increases in taxes.
c.decreases in government transfer payments.
2. Contractionary fiscal policies decrease aggregate demand and thus shift
the aggregate demand curve to the left.
II.Can Expansionary Fiscal Policy Actually Work?
A.Claim 1: Government spending always crowds out private spending.
1. This is true only if resources in the economy are always fully employed.
B.Claim 2: Government borrowing always crowds out private investment
spending.
1. This is true only if the increase in borrowing drives up interest rates.
C. Claim 3: Government budget deficits lead to reduced private spending
1. This is true only if consumers anticipate that they will have to pay higher
taxes in the future to pay off the government debt and as a result reduce
spending today in order to save money.
D.Because of the long period needed to implement fiscal policy and the sometimes long period before the effects are felt, it is often difficult to accurately
implement fiscal policy at the right time.
Teaching Tips
Fiscal Policy: The Basics
Creating Student Interest
Ask students what stage of the business cycle the economy is in. Take a poll of students
(show of hands, voice vote, or written response) and form a class consensus. Explain that
hindsight is required to know for certain where the economy is and present information
from the NBER Business Cycle Dating Committee (see the Web Resources section).
Once you have established the class consensus on the state of the economy, ask students
what they think should be done to address the state of the economy. Use this discussion
to introduce fiscal policy as the topic of this chapter.
Presenting the Material
It is important to point out the sources of tax revenue as well as the major spending areas
for governments. These data are displayed in Figures 30-2 and 30-3 in the text.
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Module 30(66)
fiscal policy basics
Personal
income
taxes,
37%
Other
taxes,
29%
Social
insurance
taxes,
27%
Corporate
profit
taxes,
7%
Other government transfers,
9%
National
defense,
13%
Medicare
and Medicaid,
20%
Social
Security,
15%
Education,
16%
Other goods
and services,
27%
In addition, demonstrate the effect of contractionary and expansionary fiscal policies using
the AD–AS model from both the long-run and short-run perspectives. Emphasize the manner in which fiscal policy can be used to close a recessionary gap or an inflationary gap as
shown in Figures 30-4 and 30-5 in the text.
Aggregate
price
level
LRAS
SRAS
P2
E2
P1
E1
AD2
AD1
Y1
YP
Recessionary gap
Potential
output
Real GDP
Module 30(66)
Aggregate
price
level
fiscal policy basics
LRAS
SRAS
P1
E1
P2
E2
AD1
AD2
Potential
output
YP
Y1
Real GDP
Inflationary gap
The text discusses three claims that are often used to explain why expansionary fiscal
policy does not work. Now that you have explained how expansionary fiscal policy works
in theory, you can explain these three claims. You might first start a discussion about the
fiscal stimulus of 2009 to see what your students know and what their opinions are. Then
you can discuss each claim. If you want more information about the American Recovery
and Reinvestment Act of 2009, here is a good place to start: http://www.recovery.gov/
Pages/default.aspx.
Common Student Pitfalls
• Transfer Payments. Students sometimes don’t understand why transfer payments
are discussed separately from government spending on goods and services. Explain
that transfer payments are different from other forms of government spending in
that transfer payments made by the government are not in direct exchange for any
goods or services received by the government.
Case Studies in the Text
Economics in Action
What Was in the Recovery Act?—This EIA discusses the American Recovery and
Reinvestment Act of 2009 in terms of whether the money was used for government
spending, tax cuts, or transfer payments.
Ask students the following questions:
1. What percentage of Recovery Act spending went for tax cuts? (Answer:
34%)
2. What percentage of Recovery Act spending went to state and local governments? (Answer: 33%)
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fiscal policy basics
Activities
Filling in the Gaps (10 minutes)
Ask students to work in pairs on the following exercises.
1. Describe a policy measure the government can use to close a recessionary
gap.
2. Illustrate your response to question 1 in a graph.
3. Describe a policy measure the government can use to close an inflationary gap.
4. Illustrate your response to question 3 in a graph.
Answers:
1. T
o close a recessionary gap the government can use expansionary fiscal
policies, such as decreasing taxes paid by businesses or households, or
increasing government spending on, say, public schools or roads.
2. Aggregate
LRAS
price
SRAS
level
E2
P2
E1
P1
AD2
AD1
0
Y1
YP
Potential
output
Real GDP
Recessionary gap
3. To close an inflationary gap, the government can use contractionary fiscal policies, such as increasing taxes paid by businesses or households, or
decreasing government spending on, say, public hospitals and the military.
Web Resources
The following websites provide information on the state of the economy and the size of
the federal deficit and national debt:
The NBER Business Cycle Dating Committee: http://www.nber.org/cycles/main.html
Module 30(66)
fiscal policy basics
153
U.S. national debt clocks: http://www.brillig.com/debt_clock/; http://www.optimist123.
com/optimist/2006/04/the_best_debt_c.html
Federal budget data from the Congressional Budget Office: http://www.cbo.gov/
Treasury Direct: http://www.treasurydirect.gov/govt/govt.htm
Global Policy Forum: http://www.globalpolicy.org
Bureau of the Public Debt: http://www.publicdebt.treas.gov/