Download Chapter 9 Fiscal Policy

Chapter 9
Fiscal Policy
McGraw-Hill/Irwin
Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter Outline
• NONDISCRETIONARY AND
DISCRETIONARY FISCAL
POLICY
• USING FISCAL POLICY TO
COUNTERACT “SHOCKS”
• EVALUATING FISCAL POLICY
• OBAMA STIMULUS PLAN
9-2
You Are Here
9-3
Fiscal Policy
• Fiscal Policy is the purposeful movement in
government spending or tax policy designed
to direct an economy
• Discretionary Fiscal Policy: government
spending and tax changes enacted at the time
of the problem to alter the economy
• Nondiscretionary Fiscal Policy: that set of
policies that are built into the system to
stabilize the economy
9-4
How Nondiscretionary
Fiscal Policy Works
• Nondiscretionary fiscal policy consists of policies that
are built into the system so that an expansionary or
contractionary stimulus can be given automatically.
• The welfare state and the progressive income tax serve
as the built-in policies.
– If the economy is in recession, those who lose their
jobs are granted unemployment and welfare benefits
and they owe less in taxes.
– If the economy is growing at an unsustainable rate,
people are making a lot of money and are faced with
higher tax rates and there are fewer people eligible
for government benefits.
9-5
How Discretionary Fiscal Policy
Works
• If we are in a recession the fiscal policy to
stimulate the economy would consist of
– Increases in government spending
– Decreases in taxes
• If we are in an inflationary period the fiscal
policy to contract the economy would
consist of
– Decreases in government spending
– Increases in taxes
9-6
Expansionary Fiscal Policy
PI
AS
PI’
PI*
AD’
AD
RGDP*
RGDP’
RGDP
9-7
Contractionary Fiscal Policy
PI
AS
PI*
PI’
AD
AD’
RGDP’
RGDP*
RGDP
9-8
Shocks
• A Shock is any unanticipated economic
event.
– Aggregate Demand Shock: an unexpected
event which causes aggregate demand to
increase or decrease, e.g. the Sept 11, 2001
terrorist attacks.
– Aggregate Supply Shock: an unexpected
event which causes aggregate supply to
increase or decrease, e.g. Iraq’s 1990 invasion
of Kuwait and threat to Saudi Arabia.
9-9
Nondiscretionary and Discretionary
Fiscal Policy Combats a Recession
PI
AS
Shock
NDFP
PI*
AD3
DFP
AD1
AD2
RGDP*
RGDP
9-10
Nondiscretionary and Discretionary
Fiscal Policy Combats an Overheated
Economy
PI
AS
Shock
NDFP
DFP
PI*
AD2
AD3
AD1
RGDP*
RGDP
9-11
Evaluating
Nondiscretionary Fiscal Policy
• Most economists believe that the builtin stabilizers have had a modestly
positive effect on diminishing the
severity of modern recessions.
9-12
The Mistiming of
Discretionary Fiscal Policy
• Recognition Lag: the time it takes to
measure the state of the economy
• Administrative Lag: the time it takes for
Congress to agree on a course of action
with the president
• Operational Lag: the time it takes for the
full impact of a government program or tax
change to have its effect on the economy
9-13
Political Problems
with Fiscal Policy
• Expansionary bias is the problem where
politicians are more willing to deal with
recessions with tax cuts and spending
increases than they are to deal with
inflationary pressures with tax increases
and spending cuts.
• The Political Business Cycle suggests that
politically motivated fiscal policy is used for
short term gain just prior to elections
9-14
The Rise, Fall and Rebirth of
Discretionary Fiscal Policy
• Between 1975 and 2001 fiscal policy was pretty
much abandoned as a mechanism for controlling
the economy.
• Monetary policy was used to expand or contract
prices and GDP.
• In 2001, the impending recession motivated tax
rebates and the Sept. 11 attacks motivated a
variety of tax cut and spending increase ideas in
Congress.
• In 2003, the continuing slow growth motivated a
renewal of the tax credit rebate idea.
9-15
Growth Rates by Presidential Terms
First
Truman
Second
Third
Fourth
-0.5%
8.7%
7.7%
3.8%
Eisenhower I
4.6%
-0.7%
7.1%
1.9%
Eisenhower II
2.0%
-1.0%
7.1%
2.5%
Kennedy/Johnson
2.3%
6.1%
4.4%
5.8%
Johnson
6.4%
6.5%
2.5%
4.8%
Nixon I
3.1%
0.2%
3.4%
5.3%
Nixon II/ Ford
5.8%
-0.5%
-0.2%
5.3%
Carter
4.6%
5.6%
3.2%
0.2%
Reagan I
2.5%
-1.9%
4.5%
7.2%
Reagan II
4.1%
3.5%
3.4%
4.1%
Bush GHW
3.5%
1.9%
-0.2%
3.3%
Clinton I
2.7%
4.0%
2.5%
3.7%
Clinton II
4.5%
4.2%
4.4%
3.7%
Bush GW I
0.8%
1.9%
3.0%
4.0%
Bush GW II
3.2%
3.3%
2.2%
-0.8%
Average
3.3%
2.8%
3.8%
4.0%
9-16
The 2003 Rebate
9-17
Obama Stimulus Plan
Stimulus Plan Element
Non-Discretionary Fiscal Policy:
Unemployment, Welfare, Medicaid
Aid to States
Discretionary Fiscal Policy: Tax Cuts
Discretionary Fiscal Policy: Spending
Increases
Amount in
Millions
$135,832
$53,600
$301,135
$300,047
9-18
Kick it Up a Notch
Aggregate Supply Shocks
9-19
Nondiscretionary and Discretionary Fiscal in
the Wake of a Negative Aggregate Supply
Shock
AS2
PI
Shock
AS1
NDFP
DFP
AD3
PI*
AD1
RGDP*
AD2
RGDP
9-20
Nondiscretionary and Discretionary Fiscal in
the Wake of a Positive Aggregate Supply
Shock
PI
AS1
Shock
AS2
PI*
NDFP
AD2
RGDP*
AD1
RGDP
9-21