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1 HO #15 Fiscal Policy Linkages Expansionary fiscal policy stimulates specific components of aggregate demand and can be inflationary: G C I G Y L  tx where consumption C is given by:  C = a + b(Y – T) and where investment expenditures I is given by:  I = j – f(i) + d() The symbol represents expected future profits. Tax revenue (T) is given by:  T = h +tx(Yt-1) If G>T, then deficit must be financed. If financed with the issuance of new government bonds by the Treasury, which in turn can reduce available funds in money markets and drive 2 up interest rates. This is referred to as crowding out private investment, or:  G>T ∆Bonds i I which suggests “crowding out” offsets, at least in part, the expansionary effects of this fiscal policy. Summary: Government spending is by definition part of aggregate demand. An increase in government spending causes the aggregate demand curve to shift to the right. A cut in tax rates will stimulate planned consumption expenditures by increasing disposable income. This also shifts the aggregate demand curve to the right. A cut in business tax rates will shift the investment expenditures curve to the right as expected future profits rise. Investment will increase to the extent that deficit spending by the government does not drive up interest rates. This also shifts the aggregate demand curve to the right. 3 Impacts on agriculture of “Contractionary” Fiscal Policy through disposable income:  (Y – T) PAG REV NY LAND NW where: PAG REV NY LAND NW Price of agricultural commodities Revenue of agricultural producers Net income of agricultural producers Farmland values Net worth of agricultural producers Income elasticity of demand for food and fiber products important here. Summary: A decline in disposable income (income after taxes): shifts the demand for agricultural commodities to the left, lowers the price of agricultural commodities, lowers revenues received by agricultural producers, and lowers net farm in agriculture. Declining net incomes reduces farm land values, which lowers net worth of agricultural producers and farm landlords. Impacts on off farm income from Contractionary Policy through unemployment rate:  Y L wr NY NW 4 where: Y L wr NY NW Gross domestic product Demand for labor Wage rate Net income of farm operator families Net worth of farm operator families Summary: A decline in aggregate demand: lowers the demand for labor by shifting the demand curve to the left. can cause wage rates to fall as fewer people are needed to produce goods and services in the economy. to the extent that farm families are also employed off the farm, their off-farm income will fall. lowers the net worth position they would have otherwise achieved.