Download Chapter Twenty Five

Chapter Twenty Five
The Government and
Fiscal Policy
Government in the Economy
Fiscal Authority: Congress and
the President and state and local
officials
Responsibilities:
–Set purchasing levels (G)
–Set taxes (T)
We’ll assume that G and T are
set at constant levels.
Disposable Income
Net Taxes: taxes minus
transfers
Disposable income: income
minus taxes
Yd = Y - T
Aggregate Expenditures
- with Government Yd = Y - T
Yd = C + S
Y-T=C+S
Y=C+S+T
AE = C + I + G
The Model Economy
 C = 500 + 0.75*(Income - Taxes)
= 500 + 0.75*Yd
 I = 50
 G = 100 and T = 60.
Equilibrium
C + I + G = AE
– 500 + 0.75*Incomed + 50 + 100 =
AE
–
650 + 0.75*Incomed =
AE
AE = Income
–650 + 0.75*Incomed = Income
–650 + 0.75*(Income - 60) = Income
–605= (1 - 0.75)*Income
–2420 = Income
Equilibrium
 Income = 2420
–
C = 500 + 0.75*(2420 - 60) = 2270
–
S = 2420 - Taxes - C = 90
 C + I + G = 2270 + 50 + 150 = 2420 = Y
 S + Taxes = 150 = 100 + 50 = G + I
Equilibrium
 Income = 2420
–
C = 500 + 0.75*(2420 - 60) = 2270
–
S = 2420 - Taxes - C = 90
 C + I + G = 2270 + 50 + 150 = 2420 = Y
 S + Taxes = 150 = 100 + 50 = G + I
Note that S + T = G + I
Aggregate
Planned
Expenditures
C+I+G
C+I
C
Government=100
Investment=$50
Savings + Taxes
650
Consumption=500+.75Yd
550
500
45o
Income
Aggregate
Planned
Expenditures
C+I+G = AE
GDP
C
650
500
45o
Y=2240
Income
Aggregate
Planned
Expenditures
C+I+G
C+I
C
Savings + Taxes
650
Consumption
550
500
45o
2240
Income
Aggregate
Planned
Expenditures
C+I+G
C+I
C
G+I
650
Consumption
550
500
45o
2240
Income
Expenditures
AE = C + I + G
C = 500 + 0.8*Y
G=50, T=0
I=40
2950
45o
2950
Income (Y)
Suppose G increases by 10, taxes increase by 0.
Expenditures
C + I + G2
C + I + G1
3000
C = 500 + 0.8*Y
G=60, T=0
I=40
2950
Y increases by 50
45o
2950
3000
Income (Y)
The Government Spending
Multiplier
DG = 10 and DY = 50
Multiplier = 50/10 = 5
Multiplier = 1/(1-MPC) = 5
Suppose T increases by 10
Expenditures
AE1 = C + I + G
AE2 = C + I +
G
C = 500 + 0.8*Y
G=50, T=10
I=40
2950
2910
2910
2950
Y decreases by
40
Income (Y)
The Tax Multiplier
DT = 10 and DY = -40
Multiplier = -40/10 = -4
Multiplier = MPC/(1-MPC) = -4
Suppose G increases by 10, T increases by 10
Expenditures
AE2 = C + I +
GAE = C + I + G
1
2960
C = 500 + 0.8*Y
G=60, T=10
I=40
2950
Y increases by 10
45o
2950 2960
Income (Y)
Balanced Budget Multiplier
DG = 10 and DY = 10
Multiplier = 10/10 = 1
Multipliers
1
1-MPC
Government
spending
multiplier
=
1
1-MPC
=
Consumption
spending
multiplier
=
=
1
1-MPC
Investment
spending
multiplier
Multipliers
1
1-MPC
Government
spending
multiplier
>
MPC
1-MPC
>
Tax
decrease
multiplier
>
>
1
Balanced
budget
multiplier
The Federal Budget, Deficit,
and Debt
Deficit = G - Taxes
–cyclical deficit: part of deficit which
is due to the business cycle
–structural deficit: part of deficit
which exists even at full employment
Receipts and Outlays
Billions of Dollars
Federal Receipts and Outlays, 1939-1994 (Billions of Current Dollars)
1600
1400
1200
1000
800
600
400
200
0
1939
Receipts
Outlays
1947
1955
1963
1971
1979
1987
1994
Years
Source: "Economic Report of the President, 1995", Table B-74, p. 435.
Federal Deficit
Federal Surplus or Deficit, 1939-1994 (Billions of Current
Dollars)
Billions of Dollars
50
0
-50
-100
-150
-200
-250
-300
1939 1943 1947 1951 1955 1959 1963 1967 1971 1975 1979 1983 1987 1991 1994
Years
Source: "Economic Report of the President, 1995", Table B-74, p. 435.
Measuring the Deficit
Deficit = Expenditures - Taxes
As a percentage of GDP
5
0
-5
-1 0
-1 5
-2 0
-2 5
-3 0
-3 5
1 99 8
1 99 4
1 99 0
1 98 6
1 98 2
1 97 8
1 97 4
1 97 0
1 96 6
1 96 2
1 95 8
1 95 4
1 95 0
1 94 6
1 94 2
1 93 8
1 93 4
Deficit as a Percentage of GDP
National Debt
The national debt refers to the
total accumulation of past
deficits.
The Economy’s Influence on
the Deficit
Fiscal drag
Tax revenues that depend on the
economy
Expenditures that depend on the
economy
Automatic stabilizers
Government Deficits and Debt as a
Percentage of nominal GDP, 1997, for
selected countries
Deficit
Debt
Canada
0.2
66.5
France
3.2
48.6
Germany
3.1
53.4
Italy
3.2
116.3
Japan
2.7
18.2
United Kingdom
2.0
47.9
United States
0.3
51.7
Review Terms & Concepts
 Automatic stabilizers
 Federal budget
 Balanced budget
 Federal debt
multiplier
 Budget deficit
 Cyclical deficit
 Discretionary fiscal
policy
 Disposable (after-tax)
income
 Federal deficit
 Fiscal drag
 Fiscal policy
 Full-employment
budget
 Government spending
multiplier
Review Terms & Concepts (cont.)
 Monetary policy
 Net exports
 Net taxes
 Privately held federal
debt
 Structural deficit
 Tax multiplier