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Fiscal Policy Fiscal policy Changes in federal taxes and purchases that are intended to achieve macroeconomic policy objectives, such as high employment, price stability, and high rates of economic growth. Chapter 15: Fiscal Policy Automatic Stabilizers versus Discretionary Fiscal Policy Automatic stabilizers Government spending and taxes that automatically increase or decrease along with the business cycle. © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 1 of 46 An Overview of Government Spending and Taxes Chapter 15: Fiscal Policy The Federal Government’s Share of Total Government Expenditures, 1929–2006 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 2 of 46 An Overview of Government Spending and Taxes Chapter 15: Fiscal Policy Federal Purchases and Federal Expenditures as a Percentage of GDP, 1950–2006 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 3 of 46 Fiscal Policy An Overview of Government Spending and Taxes Chapter 15: Fiscal Policy Federal Government Expenditures, 2006 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 4 of 46 Fiscal Policy An Overview of Government Spending and Taxes Chapter 15: Fiscal Policy Federal Government Revenue, 2006 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 5 of 46 The Effects of Fiscal Policy on Real GDP and the Price Level Looks a lot like expansionary and contractionary monetary policy …except for impacts on interest rates and investment spending Chapter 15: Fiscal Policy Fiscal Policy © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 6 of 46 The Effects of Fiscal Policy on Real GDP and the Price Level A Summary of How Fiscal Policy Affects Aggregate Demand Chapter 15: Fiscal Policy Countercyclical Fiscal Policy ACTIONS BY CONGRESS AND THE PRESIDENT RESULT PROBLEM TYPE OF POLICY Recession Expansionary Increase government spending or cut taxes Real GDP and the price level rise. Rising Inflation Contractionary Decrease government spending or raise taxes Real GDP and the price level fall. Don’t Let This Happen to YOU! Don’t Confuse Fiscal Policy and Monetary Policy © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 7 of 46 The Government Purchases and Tax Multipliers FIGURE 15.8 Chapter 15: Fiscal Policy The Multiplier Effect and Aggregate Demand © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 8 of 46 Learning Objective 15.3 The Government Purchases and Tax Multipliers Chapter 15: Fiscal Policy The Multiplier Effect of an Increase in Government Purchases This spending multiplier is analogous but not the same as the deposit multiplier © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 9 of 46 The Government Purchases and Tax Multipliers A cut in tax rates affects equilibrium real GDP through two channels: Chapter 15: Fiscal Policy (1) A cut in tax rates increases the disposable income of households, which leads them to increase their consumption spending, and (2) a cut in tax rates increases the size of the multiplier effect … it reduces the rate at which purchasing power leaks from the spending stream The less the marginal propensity to leak, the greater the spending multiplier. © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 10 of 46 The Government Purchases and Tax Multipliers Taking into Account the Effects of Aggregate Supply Chapter 15: Fiscal Policy The Multiplier Effect and Aggregate Supply © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 11 of 46 The Limits of Using Fiscal Policy Crowding out A decline in private expenditures as a to Stabilize the Economy result of an increase in government purchases. Money market Chapter 15: Fiscal Policy An Expansionary Fiscal Policy Increases Interest Rates © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 12 of 46 The Limits of Using Fiscal Policy to Stabilize the Economy Crowding Out in the Short Run FIGURE 15.12 Chapter 15: Fiscal Policy The Effect of Crowding Out in the Short Run © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 13 of 46 The Effects of Fiscal Policy in the Long Run The Economic Effect of “Supply Side” Tax Reform Chapter 15: Fiscal Policy The Supply-Side Effects of a Tax Change © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 14 of 46 Deficits, Surpluses, and Federal Government Debt Chapter 15: Fiscal Policy The Federal Budget Deficit, 1901–2006 Cyclically adjusted budget deficit or surplus The deficit or surplus in the federal government’s budget if the economy were at potential GDP. © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 15 of 46 Making the Connection Did Fiscal Policy Fail during the Great Depression? Chapter 15: Fiscal Policy FEDERAL GOVERNMENT EXPENDITURES (BILLIONS OF DOLLARS Although government spending increased during the Great Depression, the cyclically adjusted budget was in surplus most years. ACTUALFEDERAL BUDGET DEFICIT OR SURPLUS (BILLIONS OF DOLLARS) CYCLICALLY ADJUSTED BUDGET DEFICIT OR SURPLUS (BILLIONS OF DOLLARS) CYCLICALLY ADJUSTED BUDGET DEFICIT OR SURPLUS AS A PERCENTAGE OF GDP 1929 $2.6 $1.0 $1.24 1.20% 1930 2.7 0.2 0.81 0.89 1931 4.0 -2.1 -0.41 -0.54 1932 3.0 -1.3 0.50 0.85 1933 3.4 -0.9 1.06 1.88 1934 5.5 -2.2 0.09 0.14 1935 5.6 -1.9 0.54 0.74 1936 7.8 -3.2 0.47 0.56 1937 6.4 0.2 2.55 2.77 1938 7.3 -1.3 2.47 2.87 1939 8.4 -2.1 2.00 2.17 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 16 of 46 Deficits, Surpluses, and Federal Government Debt The Federal Government Debt Chapter 15: Fiscal Policy The Federal Government Debt, 1901–2006 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 17 of 46 Chapter 15: Fiscal Policy Key Terms Automatic stabilizers Budget deficit Budget surplus Crowding out Cyclically adjusted budget deficit or surplus Fiscal policy Multiplier effect Tax wedge © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 18 of 46