Survey
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
Chapter 10 Fiscal policy and the public debt Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal 10-1 Learning Objectives • Briefly outline the nature of federal government expenditures and revenues. • Explain how a degree of economic stability is built into our tax system. • Survey some basic problems in the application of fiscal policy. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal 10-2 Learning Objectives (cont.) • Briefly discuss several contrasting budget philosophies. • Assess the quantitative and qualitative aspects of the public debt. • Discuss the implications of and complications associated with fiscal policy within the aggregate demand–aggregate supply framework. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal 10-3 Federal Government Finance • Federal expenditures – large expenditure on social security and welfare – specific purpose grants • Federal revenues – personal income tax – company income tax Double taxation a highly controversial problem – Indirect and other taxes sales tax excise tax. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal 10-4 Discretionary Fiscal Policy • The deliberate manipulation of taxes and spending by government for the purpose of altering real GDP and employment, controlling inflation and stimulating economic growth. • Not all fiscal policy is deliberate. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal 10-5 Expansionary Fiscal Policy • The use of increased government spending and/or lower taxes, thereby increasing the government budget deficit, to stimulate economic activity and the move the economy out of recession or depression. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal 10-6 Contractionary Fiscal Policy • The use of reductions in government spending and/or higher taxes, thereby reducing the deficit or increasing the surplus in the government’s budget, to control demand-pull inflation. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal 10-7 Financing Deficits • Effect of an expansionary fiscal policy depends on the method by which the deficit is financed – Borrowing: May increase interest rates, thus ‘crowding out’ some investment spending and some interest-sensitive consumer spending. – Money creation: Deficit financed by the RBA by issuing new money Avoids crowding out of private spending. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal 10-8 Disposing of Surpluses • Effect of contractionary fiscal policy depends on the method by which the surplus (or movement towards surplus) is financed. – Debt reduction: May reduce anti-inflationary impact of policy by reducing interest rates, thereby stimulating private spending. – Idle surplus (or impounding): when the government withholds purchasing power. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal 10-9 Non-Discretionary Fiscal Policy • Built-in stabilisers that operate without requiring explicit action by policy-makers. • During recessions: Tend to increase government deficits (or reduce surplus). • During inflationary periods: Tend to increase government surpluses (or reduce deficits). Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal 10-10 Automatic or Built-in Stabilisers • Tax receipts: Increase as real GDP increases. • Transfers: Decrease as real GDP increases. • Do not correct; only reduce the severity of fluctuations. • Useful when economy is operating around full employment. • Can cause problems: Fiscal Drag. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal 10-11 T { Government expenditure and tax revenue ($ billions) Built-in Stabilisers Deficit { GDP3 GDP1 Surplus G GDP2 Real GDP (billions) Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal 10-12 Fiscal Drag • Occurs when an economy stabilises at an undesirable output level because of the operation of automatic stabilisers. • Over time as an economy grows, this can choke off growth. • The cure is: Discretionary fiscal policy. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal 10-13 Cyclically Adjusted Budget • Indicates what the budget deficit (or surplus) would be if the economy were to operate at potential output throughout the year. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal 10-14 Problems with Fiscal Policy in Practice • Problems of timing – recognition lag – administrative lag – operational lag • Political problems – other economic goals: not just stability – expansionary bias – a political business cycle. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal 10-15 Problems with Fiscal Policy in Practice (cont.) • Crowding-out effect – When an expansionary fiscal policy tends to increase the interest rate, thus reducing interest-sensitive private spending, especially investment. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal 10-16 Managing Public Debt: Various Philosophies • Annually balanced budget – pro-cyclical: intensifies recession or inflation • Cyclically balanced budget – counter-cyclical – not annually balanced – problem: upswings and downswings may not be of equal magnitude. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal 10-17 Managing Public Debt: Various Philosophies (cont.) • Functional finance – Primary purpose is to balance the economy, not the budget. – The problems of continuing annual deficits (or surpluses) may be small compared to the alternative: recession and high unemployment (inflation). Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal 10-18 Public Debt • The total accumulation of the Federal Government’s total deficits and surpluses over time. Myths about public debt: • Government is going bankrupt. – Government can refinance existing debt. – Government can create more money. • Shifting burdens, future generations will pay for it. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal 10-19 Problems with Public Debt Economic implications: • External debt may be a problem. • Increased taxes may dampen incentives. • Income distribution affected. – Government bonds are generally held by those wealthier members of society. • Composition important: capital versus consumer goods. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal 10-20 Problems with Public Debt (cont.) Crowding-out and the stock of capital. • Future generations inherit a smaller stock of capital goods due to the crowding-out effect, which increases interest rates and so reduces investment spending. • Two qualifications – public investment – unemployment. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal 10-21 Public Debt: Positive Role • Debt creation transfers saving to spenders and thereby may play a positive function in maintaining a high level of output and employment. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal 10-22 Inflation and Fiscal Policy • Some portion of the potential effect of an expansionary fiscal policy on real output and employment may be dissipated in the form of inflation. • The effect of fiscal policy on inflation affects net exports through the foreign purchases effect. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal 10-23 No Crowding-Out Effect ASLS AS Price level AD1 P3 P2 P1 AD2 Q1 Q2 AD3 Qp Real gross domestic product Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal 10-24 Crowding-Out Effect AS Price level ASLS AD1 P3 P2 P1 AD2 Q1 AD3 Q2 Qp Real gross domestic product Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal 10-25 Fiscal Policy and the Open Economy • The effectiveness of fiscal policy can be altered by international conditions: – shocks from abroad: Small economies are susceptible to international shocks that can alter our GDP and render our fiscal policies inappropriate. – net export effect. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal 10-26 Net Export Effect • The impact of interest rate-induced change in the exchange rate, and thus net exports, following changes in fiscal policy. – Expansionary fiscal policy results in higher interest rates, resulting in increased demand for $A, resulting in appreciation of $A, resulting in a decline in net exports. – Contractionary fiscal policy results in lower interest rates, resulting in decreased demand for $A, resulting in depreciation of $A resulting in an increase in net exports. • Reduces the overall impact of fiscal policy Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal 10-27 Fiscal Policy and Aggregate Supply • Fiscal policy, especially tax changes, affects not only aggregate demand but can affect aggregate supply. • Tax changes in the form of incentives to businesses and individuals can lead to a rightward shift in the AS, providing a further stimulus to the economy in terms of lower prices and higher GDP. Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal 10-28 Supply-Side Effect of Fiscal Policy Price level AD1 P3 ASLS AS1 AS2 P2 = P1 AD2 Q1 Q2 Q3 Qp Real gross domestic product Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal 10-29 Next Chapter: Monetary policy and the financial system Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal 10-30