Download Fiscal Policy Linkages

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HO #15
Fiscal Policy Linkages
Expansionary fiscal policy stimulates specific components of
aggregate demand and can be inflationary:
G
 C I G  Y  L
[1]
tx
where consumption C is given by:
[2] C = a + b(Y – T)
and where investment expenditures I is given by:
[3] I = j – f(i) + d()
The symbol  represents expected future profits.
Tax revenue (T) is given by:
[4] 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
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up interest rates. This is referred to as crowding out private
investment, or:
[5] 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.
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Impacts on agriculture of “Contractionary” Fiscal
Policy through disposable income:
[6] (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:
[7]
Y  L  wr 
NY  NW
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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.