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12 C HAPTE R FISCAL POLICY •Employment Act of 1946 •Commits the Federal Government to take action on the economy •Council of Economic Advisors (CEA) Assist the President •Joint Economic Committee (JEC) Assist Congress LEGISLATIVE MANDATES FISCAL POLICY AND THE AD-AS MODEL Two Options • Discretionary Fiscal Policy •“Active” •May cause a budget deficit • Non-Discretionary Fiscal Policy •“Passive” or Automatic stabilizers Expansionary Fiscal Policy • Increase Government Spending • Tax Reductions • Combinations of the Two EXPANSIONARY FISCAL POLICY the multiplier at work... $5 billion initial increase in spending Price level Full $20 billion increase in aggregate demand P1 AD1 AD2 $485 $505 Real GDP (billions) CONTRACTIONARY FISCAL POLICY the multiplier at work... Price level P4 P3 $5 billion initial decrease in spending Full $20 billion decrease in aggregate demand AD4 AD3 $515 Real GDP (billions) FINANCING OF DEFICITS AND DISPOSING OF SURPLUSES •Borrowing vs. New Money •Borrowing From The Public •Money Creation •Debt Retirement vs. Idle Surplus •Debt Reduction •Impounding Which Policy Option? G or T? BUILT-IN STABILITY Net tax revenues vary directly with GDP Transfer payments behave the opposite way as tax collections Automatic or Built-In Stabilizers Economic Importance Government Expenditures, G, and Tax Revenues, T BUILT-IN STABILITY T Surplus G Deficit GDP1 GDP2 GDP3 Real Domestic Output, GDP BUILT-IN STABILITY Tax Progressivity • Progressive Tax System • Proportional Tax System • Regressive Tax System The more progressive the tax system, the greater the economy’s built-in stability EVALUATING FISCAL POLICY Full-Employment Budget Cyclical Deficit Recent U.S. Deficits & Surpluses Year Actual Deficit or Surplus 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 -3.9% -4.5 -4.7 -3.9 -2.9 -2.2 -1.4 -0.3 +0.8 +1.4 +2.4 Full-Employment Deficit or Surplus -2.1% -2.6 -3.0 -2.6 -2.0 -1.9 -1.2 -0.9 -0.4 +0.3 +1.1 Government Expenditures, G, and Tax Revenues, T (billions) FULL-EMPLOYMENT DEFICITS $500 475 450 425 No Change in Fiscal Policy b a c GDP2 GDP1 Year 2 Year 1 Real Domestic Output, GDP T1 G Government Expenditures, G, and Tax Revenues, T (billions) FULL-EMPLOYMENT DEFICITS $500 475 450 425 Discretionary Fiscal Policy Tax Decrease e f d h g GDP4 GDP3 Year 4 Year 3 Real Domestic Output, GDP T1 T2 G PROBLEMS, CRITICISMS, AND COMPLICATIONS •Problems of Timing • Recognition Lag • Administrative Lag • Operational Lag •A Political Business Cycle? • Offsetting State & Local Finance •Crowding-Out Effect FISCAL POLICY, AGGREGATE SUPPLY AND INFLATION Price level AS Fiscal Policy: Pure & Simple P1 AD1 $495 AD2 $515 Real GDP (billions) FISCAL POLICY, AGGREGATE SUPPLY AND INFLATION AS Fiscal Policy and the Crowding-Out Effect or the Net Export Effect Price level AD1 P1 AD2 AD’2 $495$505$515 Real GDP (billions) FISCAL POLICY, AGGREGATE SUPPLY AND INFLATION Price level AS Fiscal Policy And Inflation P1 AD1 AD2 $495 $505 $515 Real GDP (billions) FISCAL POLICY IN THE OPEN ECONOMY Shocks Originating from Abroad Net Export Effect SUPPLY-SIDE FISCAL POLICY Emphasis on Expansionary Tax Cuts Impact upon... • Saving and Investment • Work Incentives • Risk Taking SUPPLY-SIDE FISCAL POLICY Price level AS1 AS2 P2 P3 P1 AD2 AD1 0 Q 1 Q2 Q3 Real domestic output, GDP Forecasting the Future The Leading Indicators • Average Workweek • Initial Claims for Unemployment Insurance • New Orders for Consumer Goods • Vendor Performance • New Orders for Capital Goods • Building Permits for Houses • Stock Prices • Money Supply • Interest-Rate Spread • Consumer Expectations Forecasting the Future The Leading Indicators • Average Workweek • Initial Claims for Unemployment Insurance • New Orders for Consumer Goods • Vendor Performance • New Orders for Capital Goods • Building Permits for Houses • Stock Prices • Money Supply • Interest-Rate Spread • Consumer Expectations Chapter Conclusions fiscal policy progressive tax system Employment Act of 1946 proportional tax system Council of Economic Advisers (CEA) regressive tax system expansionary fiscal policy cyclical deficit budget deficit political business cycle contractionary fiscal policy crowding-out effect budget surplus supply-side fiscal policy full-employment budget net export effect built-in stabilizer Copyright McGraw-Hill/Irwin, 2002 BACK END Chapter 13 Money and Banking Next...
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