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Legislative Mandate Fiscal Policy and the AD-AS Model Expansionary and Contractionary Fiscal Policy Financing of Deficits and Disposing of Surpluses Built-In Stability Evaluating Fiscal Policy Problems, Criticisms, and Complications Fiscal Policy in the Open Economy Forecasting the Future 12 C HAPTE R FISCAL POLICY Key Terms Previous Slide End Show 12 - 1 Next Slide Copyright McGraw-Hill/Irwin, 2005 LEGISLATIVE MANDATES Legislative Mandate Fiscal Policy and the AD-AS Model Expansionary and Contractionary Fiscal Policy Financing of Deficits and Disposing of Surpluses Employment Act of 1946 Council of Economic Built-In Stability Evaluating Fiscal Policy Problems, Criticisms, and Complications Advisors (CEA) Fiscal Policy in the Open Economy Forecasting the Future Key Terms Previous Slide End Show 12 - 2 Next Slide Joint Economic Committee (JEC) Copyright McGraw-Hill/Irwin, 2005 FISCAL POLICY AND THE AD-AS MODEL Legislative Mandate Fiscal Policy and the AD-AS Model Expansionary and Contractionary Fiscal Policy Financing of Deficits and Disposing of Surpluses Built-In Stability Evaluating Fiscal Policy Problems, Criticisms, and Complications Fiscal Policy in the Open Economy Forecasting the Future Key Terms Previous Slide End Show 12 - 3 Next Slide Two Options • Discretionary Fiscal Policy • Non-Discretionary Fiscal Policy Expansionary Fiscal Policy To Reduce Unemployment… • Increase Government Spending • Tax Reductions • Combinations of the Two Copyright McGraw-Hill/Irwin, 2005 EXPANSIONARY FISCAL POLICY the multiplier at work... Legislative Mandate $5 billion initial increase in spending Fiscal Policy and the AD-AS Model Expansionary and Contractionary Fiscal Policy Built-In Stability Evaluating Fiscal Policy Problems, Criticisms, and Complications Fiscal Policy in the Open Economy Price level Financing of Deficits and Disposing of Surpluses AS Full $20 billion increase in aggregate demand P1 Forecasting the Future Key Terms Previous Slide End Show 12 - 4 Next Slide AD2 $490 AD1 $510 Real GDP (billions) Copyright McGraw-Hill/Irwin, 2005 FISCAL POLICY AND THE AD-AS MODEL Legislative Mandate Fiscal Policy and the AD-AS Model Expansionary and Contractionary Fiscal Policy Financing of Deficits and Disposing of Surpluses Built-In Stability Evaluating Fiscal Policy Problems, Criticisms, and Complications Fiscal Policy in the Open Economy Forecasting the Future Key Terms Previous Slide End Show 12 - 5 Next Slide Contractionary Fiscal Policy To Reduce Inflation… • Decrease Government Spending • Tax Increases • Combinations of the Two Copyright McGraw-Hill/Irwin, 2005 CONTRACTIONARY FISCAL POLICY the multiplier at work... Legislative Mandate $5 billion initial decrease in spending Fiscal Policy and the AD-AS Model Expansionary and Contractionary Fiscal Policy Built-In Stability Evaluating Fiscal Policy Problems, Criticisms, and Complications Fiscal Policy in the Open Economy Price level Financing of Deficits and Disposing of Surpluses AS P2 Full $20 billion decrease in aggregate demand P1 Forecasting the Future Key Terms AD3 Previous Slide End Show 12 - 6 Next Slide AD4 $510 $522 Real GDP (billions) Copyright McGraw-Hill/Irwin, 2005 Legislative Mandate Fiscal Policy and the AD-AS Model Expansionary and Contractionary Fiscal Policy Financing of Deficits and Disposing of Surpluses Built-In Stability Evaluating Fiscal Policy Problems, Criticisms, and Complications Fiscal Policy in the Open Economy Forecasting the Future Key Terms Previous Slide End Show 12 - 7 Next Slide 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? Copyright McGraw-Hill/Irwin, 2005 Legislative Mandate Fiscal Policy and the AD-AS Model Expansionary and Contractionary Fiscal Policy Financing of Deficits and Disposing of Surpluses Built-In Stability Evaluating Fiscal Policy Problems, Criticisms, and Complications Fiscal Policy in the Open Economy Forecasting the Future Key Terms Previous Slide End Show 12 - 8 Next Slide 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 Copyright McGraw-Hill/Irwin, 2005 BUILT-IN STABILITY Legislative Mandate Expansionary and Contractionary Fiscal Policy Financing of Deficits and Disposing of Surpluses Built-In Stability Evaluating Fiscal Policy Problems, Criticisms, and Complications Fiscal Policy in the Open Economy Forecasting the Future Key Terms Previous Slide End Show 12 - 9 Next Slide Government Expenditures, G, and Tax Revenues, T Fiscal Policy and the AD-AS Model T Surplus G Deficit GDP1 GDP2 GDP3 Real Domestic Output, GDP Copyright McGraw-Hill/Irwin, 2005 Legislative Mandate Fiscal Policy and the AD-AS Model Expansionary and Contractionary Fiscal Policy Financing of Deficits and Disposing of Surpluses Built-In Stability Evaluating Fiscal Policy Problems, Criticisms, and Complications Fiscal Policy in the Open Economy Forecasting the Future Key Terms Previous Slide End Show 12 - 10 Next Slide 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. Copyright McGraw-Hill/Irwin, 2005 FULL-EMPLOYMENT DEFICITS Legislative Mandate Expansionary and Contractionary Fiscal Policy Financing of Deficits and Disposing of Surpluses Built-In Stability Evaluating Fiscal Policy Problems, Criticisms, and Complications Fiscal Policy in the Open Economy Forecasting the Future Key Terms Previous Slide End Show 12 - 11 Next Slide Government Expenditures, G, and Tax Revenues, T (billions) Fiscal Policy and the AD-AS Model $500 475 450 425 No Change in Fiscal Policy b a c GDP2 GDP1 (Year 2) (Year 1) Real Domestic Output, GDP Copyright McGraw-Hill/Irwin, 2005 T1 G FULL-EMPLOYMENT DEFICITS Legislative Mandate Expansionary and Contractionary Fiscal Policy Financing of Deficits and Disposing of Surpluses Built-In Stability Evaluating Fiscal Policy Problems, Criticisms, and Complications Fiscal Policy in the Open Economy Forecasting the Future Key Terms Previous Slide End Show 12 - 12 Next Slide Government Expenditures, G, and Tax Revenues, T (billions) Fiscal Policy and the AD-AS Model $500 475 450 425 Discretionary Fiscal Policy Tax Decrease e f d h g GDP4 GDP3 Year 4 Year 3 Real Domestic Output, GDP Copyright McGraw-Hill/Irwin, 2005 T1 T2 G EVALUATING FISCAL POLICY Legislative Mandate Fiscal Policy and the AD-AS Model Expansionary and Contractionary Fiscal Policy Financing of Deficits and Disposing of Surpluses Built-In Stability Evaluating Fiscal Policy Problems, Criticisms, and Complications Fiscal Policy in the Open Economy Forecasting the Future Key Terms Previous Slide End Show 12 - 13 Next Slide Full-Employment Budget Cyclical Deficit Recent U.S. Deficits & Surpluses Year Actual Deficit or Surplus Full-Employment Deficit or Surplus 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 -3.9% -4.5% -4.7% -3.9% -2.9% -2.2% -1.4% -0.3% +0.8% +1.4% +2.4% +1.3% -1.5% -2.1% -2.4% -2.9% -2.8% -2.1% -2.0% -1.3% -0.9% -0.4% +0.3% +1.1% +0.8% -1.5% Copyright McGraw-Hill/Irwin, 2005 GLOBAL PERSPECTIVE Legislative Mandate Fiscal Policy and the AD-AS Model Expansionary and Contractionary Fiscal Policy Financing of Deficits and Disposing of Surpluses Built-In Stability Evaluating Fiscal Policy Problems, Criticisms, and Complications Fiscal Policy in the Open Economy Forecasting the Future Key Terms Previous Slide End Show 12 - 14 Next Slide BUDGET DEFICITS OR SURPLUSES AS A PERCENTAGE OF GDP, 2002 -6 -4 -2 0 2 4 Italy Sweden Canada United Kingdom France United States Ireland Norway Japan Source: Organization for Economic Development and Cooperation Copyright McGraw-Hill/Irwin, 2005 Legislative Mandate Fiscal Policy and the AD-AS Model Expansionary and Contractionary Fiscal Policy Financing of Deficits and Disposing of Surpluses Built-In Stability Evaluating Fiscal Policy Problems, Criticisms, and Complications Fiscal Policy in the Open Economy Forecasting the Future Key Terms Previous Slide End Show 12 - 15 Next Slide PROBLEMS, CRITICISMS, AND COMPLICATIONS •Problems of Timing • Recognition Lag • Administrative Lag • Operational Lag •Political Considerations • Political Business Cycles •Offsetting State & Local Finance •Crowding-Out Effect Copyright McGraw-Hill/Irwin, 2005 Legislative Mandate FISCAL POLICY, AGGREGATE SUPPLY AND INFLATION Fiscal Policy and the AD-AS Model Expansionary and Contractionary Fiscal Policy Built-In Stability Evaluating Fiscal Policy Problems, Criticisms, and Complications Fiscal Policy in the Open Economy Price level Financing of Deficits and Disposing of Surpluses AS Fiscal Policy: No Complications P1 Forecasting the Future Key Terms Previous Slide End Show 12 - 16 Next Slide AD1 $490 AD2 $510 Real GDP (billions) Copyright McGraw-Hill/Irwin, 2005 Legislative Mandate FISCAL POLICY, AGGREGATE SUPPLY AND INFLATION Fiscal Policy and the AD-AS Model Expansionary and Contractionary Fiscal Policy Built-In Stability Evaluating Fiscal Policy Problems, Criticisms, and Complications Fiscal Policy in the Open Economy Price level Financing of Deficits and Disposing of Surpluses AS Fiscal Policy: Showing Crowding-out Effect or Net Export Effect P1 Forecasting the Future Key Terms Previous Slide End Show 12 - 17 Next Slide AD1 AD’2 AD2 $490 $510 $504 Real GDP (billions) Copyright McGraw-Hill/Irwin, 2005 Legislative Mandate FISCAL POLICY IN THE OPEN ECONOMY Fiscal Policy and the AD-AS Model Expansionary and Contractionary Fiscal Policy Financing of Deficits and Disposing of Surpluses Shocks Originating from Abroad Built-In Stability Evaluating Fiscal Policy Problems, Criticisms, and Complications Net Export Effect Fiscal Policy in the Open Economy Forecasting the Future Key Terms Previous Slide End Show 12 - 18 Next Slide Copyright McGraw-Hill/Irwin, 2005 Forecasting the Future Legislative Mandate Fiscal Policy and the AD-AS Model Expansionary and Contractionary Fiscal Policy Financing of Deficits and Disposing of Surpluses Built-In Stability Evaluating Fiscal Policy Problems, Criticisms, and Complications Fiscal Policy in the Open Economy Forecasting the Future Key Terms Previous Slide End Show 12 - 19 Next Slide 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 Copyright McGraw-Hill/Irwin, 2005 fiscal policy progressive tax system Employment Act of 1946 proportional tax system Council of Economic regressive tax system Advisers (CEA) full-employment budget expansionary fiscal policy cyclical deficit budget deficit political business cycle contractionary fiscal policy crowding-out effect budget surplus net export effect built-in stabilizer Copyright McGraw-Hill/Irwin, Inc., 2005 BACK END Legislative Mandate Chapter 13 Fiscal Policy and the AD-AS Model Expansionary and Contractionary Fiscal Policy Financing of Deficits and Disposing of Surpluses Built-In Stability Evaluating Fiscal Policy Problems, Criticisms, and Complications Fiscal Policy in the Open Economy Forecasting the Future Key Terms Previous Slide End Show 12 - 21 Next Slide Money and Banking Next... Copyright McGraw-Hill/Irwin, 2005
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