Download 9 - AI3

ECONOMICS 5e
Michael Parkin
CHAPTER
13
Fiscal Policy
Copyright © 2000 Addison Wesley Longman, Inc.
Chapter 30 in Economics
Slide 13-1
Learning Objectives
• Describe the federal budget process
• Describe the recent history of federal
expenditures, tax revenues, and the budget
deficit
• Distinguish between automatic and
discretionary fiscal policy
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-2
Learning Objectives (cont.)
• Define and explain the fiscal policy
multipliers
• Explain the effects of fiscal policy in both
the short run and the long run
• Distinguish between and explain the
demand-side and supply-side effects of
fiscal policy
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-3
Learning Objectives
• Describe the federal budget process
• Describe the recent history of federal
expenditures, tax revenues, and the budget
deficit
• Distinguish between automatic and
discretionary fiscal policy
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-4
The Federal Budget
The federal budget is the annual statement
of the expenditures and tax revenues of the
government of the United States together
with the laws and regulations that approve
and support those expenditures and taxes.
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-5
The Federal Budget
The federal budget's two purposes are:
1) To finance the activities of the federal
government.
2) To stabilize the economy.
Fiscal policy is the use of the federal budget
to achieve macroeconomic objectives such
as full employment, sustained economic
growth, and price stability.
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-6
The Federal Budget
The Institutions and Laws
The Roles of the President and Congress
• The President proposes a budget to Congress
each February.
• After Congress has passed those acts into
law or vetoes them.
• The President approves or vetoes the entire
budget bill.
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-7
The Federal Budget
The Institutions and Laws (cont.)
The Roles of the President and Congress
• The president does not have the veto power
to eliminate specific items in a budget bill
and approve others - known as line item veto.
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-8
The Federal Budget
Time Line in 2000–01
Jan 1,2000
Feb 6, 2000
MarchSeptemberOct 1, 2000
The President submits a budget proposal to Congress.
Congress debates, amends, and enacts the budget.
Fiscal year 2001 begins.
Supplementary budget laws may be passed.
State of economy influences expenditures,
tax revenues, and the budget deficit.
Oct 1, 2001
Accounts of fiscal year 2001 are prepared.
Expenditures, tax revenues, and the budget deficit
are reported.
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-9
The Federal Budget
The Employment Act of 1946
“it is the continuing policy and responsibility of
the Federal Government to use all practicable
means...to coordinate and utilize all its plans,
functions, and resources . . . to promote
maximum employment, production, and
purchasing power.”
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-10
The Federal Budget
The Employment Act of 1946
The President must describe the current
economic situation and the policies he believes
are needed in an annual Economic Report of the
President.
• Written by the Council of Economic Advisors.
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-11
The Federal Budget
The Council of Economic Advisors
• Established by the Employment Act.
• Consists of a Chair and two other members.
• They are economists on leave from their regular
positions.
• Typically serve two or three years.
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-12
Learning Objectives
• Describe the federal budget process
• Describe the recent history of federal
expenditures, tax revenues, and the budget
deficit
• Distinguish between automatic and
discretionary fiscal policy
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-13
The Federal Budget
Highlights of the 1997 Budget
Tax Revenues are the governments receipts
The sources of tax revenue are:
1) Personal income taxes
2) Social insurance taxes
3) Corporate income taxes
4) Indirect taxes
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-14
The Federal Budget
Highlights of the 1997 Budget
Expenditures are the government's outlays
The three categories of expenditures are:
1) Transfer payments
2) Purchases of goods and services
3) Debt interest
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-15
The Federal Budget
Highlights of the 1997 Budget
• A budget deficit is the amount by which the
government’s expenditures exceed its tax
revenues.
• A balanced budget exists if tax revenues equal
expenditures.
• A budget surplus exists if tax revenues exceed
expenditures.
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-16
Federal Budget in Fiscal 1997
Projections
Item
Tax Revenues
(billions of dollars)
1,505
Personal income taxes
Social insurance taxes
Corporate income taxes
Indirect taxes
Expenditures
673
536
176
120
1,631
Transfer payments
Purchases of goods and services
Debt interest
Deficit
Copyright © 2000 Addison Wesley Longman, Inc.
1,060
324
247
126
Slide 13-17
The Federal Budget
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-18
Federal Government Tax
Revenues and Expenditures
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-19
Federal Government Tax
Revenues and Expenditures
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-20
The Federal Budget
Deficit and Debt
Government debt is the sum of past government
deficits minus the sum of past surpluses.
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-21
The Federal Government Debt
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-22
Government Deficits
Around the World in 1998
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-23
The Federal Budget
State and Local Budgets
• In 1997 federal government expenditures were
$1,631 billion.
• In 1997 state and local expenditures were
$1,050 billion.
• Most was spent on public schools, colleges and
universities, local police and fire services, and roads.
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-24
Learning Objectives
• Describe the federal budget process
• Describe the recent history of federal
expenditures, tax revenues, and the budget
deficit
• Distinguish between automatic and
discretionary fiscal policy
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-25
Fiscal Policy Multipliers
Automatic fiscal policy is a change in fiscal
policy that is triggered by the state of the
economy (e.g. unemployment
compensation).
Discretionary fiscal policy is a policy action
that is initiated by an act of Congress.
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-26
Learning Objectives
• Define and explain the fiscal policy
multipliers
• Explain the effects of fiscal policy in both
the short run and the long run
• Distinguish between and explain the
demand-side and supply-side effects of
fiscal policy
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-27
Fiscal Policy Multipliers
We will assume, in the model we build, that
all taxes are lump-sum taxes.
Lump-sum taxes are taxes that do not vary with
real GDP (e.g. property taxes).
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-28
Fiscal Policy Multipliers
The Government Purchases Multiplier
The government purchases multiplier is the
magnification effect of a change in government
purchases of goods and services on equilibrium
expenditure and real GDP.
1
Government purchase multiplier =
1 – MPC
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-29
The Government
Purchases Multiplier
Real
GDP
(Y)
Taxes
(T)
Disposable Consumption
income
expenditure
(Y-T)
(C)
Investment
(I)
Initial
government
purchases
(G)
Initial
aggregate
New
planned
government
expenditure
purchases
(AE=C+I+G)
(G')
New
aggregate
planned
expenditure
(AE'=C+I+G)
(trillions of dollars)
a
5.0 0.5
4.5
3.75
1.0
0.5
5.25
1.0
5.75
b
6.0 0.5
5.5
4.50
1.0
0.5
6.00
1.0
6.50
c
7.0 0.5
6.5
5.25
1.0
0.5
6.75
1.0
7.25
d
8.0 0.5
7.5
6.00
1.0
0.5
7.50
1.0
8.00
e
9.0 0.5
8.5
6.75
1.0
0.5
8.25
1.0
8.75
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-30
Aggregate expenditure
(trillions of 1992 dollars)
The Government Purchases Multiplier
9
A $0.5 trillion increase in
government purchases shifts the
AE curve upward by $0.5 trillion.
e
c'
7
5
0
b'
a'
AE1
e' AE0
d'
8
6
o
45 line
d
c
b
1
4
(1  0.75)
a
5
6
…and increases
real GDP by
$2 trillion. The
government
purchases
multiplier is
7
8
9
Real GDP (trillions of 1992 dollars)
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-31
Fiscal Policy Multipliers
The Lump-Sum Tax Multiplier
The lump-sum tax multiplier is the
magnification effect of a change in lump-sum
taxes on equilibrium expenditure and real GDP.
Because a tax increase leads to a decrease in
expenditure, the multiplier is negative.
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-32
Fiscal Policy Multipliers
The Lump-Sum Tax Multiplier
Furthermore, since a change in lump-sum taxes
changes aggregate expenditure initially by only
MPC multiplied by the tax change, the lumpsum tax multiplier is:
–MPC
Lump-sum tax multiplier =
1 – MPC
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-33
Aggregate expenditure
(trillions of 1992 dollars)
The Lump-Sum Tax Multiplier
9
o
45 line
A $1 trillion tax increase
shifts the AE curve downward
by $0.75 trillion...
AE1
8
…and decreases
real GDP by
$3 trillion. The
tax multiplier is
7
6
 0.75
 3
(1  0.75)
5
0
AE0
5
6
7
8
9
Real GDP (trillions of 1992 dollars)
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-34
Fiscal Policy Multipliers
The Lump-Sum Transfer Payments
Multiplier
Transfer payments are like negative taxes.
An increase in transfer payments works like a
decrease in taxes.
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-35
Fiscal Policy Multipliers
The Lump-Sum Transfer Payments
Multiplier
Therefore, the multiplier is positive:
MPC
Lump-sum transfer
=
payments multiplier
1 – MPC
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-36
Fiscal Policy Multipliers
Induced Taxes and Entitlement Spending
• Induced taxes are taxes that vary with real GDP.
• Entitlement spending is government spending
on programs that entitle suitably qualified
people and businesses to receive benefits.
• It results in transfer payments that depend on the
economic state of individual citizens and businesses.
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-37
Fiscal Policy Multipliers
Induced Taxes and Entitlement Spending
(cont.)
• These decrease the multiplier effects of changes
in government purchases and lump-sum taxes.
• They weaken the link between real GDP and
disposable income.
• The extent to which they decrease the
multiplier depends on the marginal tax rate.
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-38
Fiscal Policy Multipliers
Induced Taxes and Entitlement Spending
(cont.)
• The higher the marginal tax rate, the smaller is
the multiplier effect of a change in government
purchases or lump-sum taxes.
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-39
Fiscal Policy Multipliers
International Trade and Fiscal Policy
Multipliers
The larger the marginal propensity to import,
the smaller is the increase in consumption
expenditure induced by an increase in real GDP
and the smaller are the government purchases
and lump-sum tax multipliers.
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-40
Fiscal Policy Multipliers
Automatic Stabilizers
Mechanisms that stabilize real GDP without
explicit action by the government.
A decrease in real GDP leads to a fall in tax
revenues and an increase in transfer
payments.
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-41
Fiscal Policy Multipliers
Budget Deficit Over the Business Cycle
1) Generally speaking, when the economy
is in the expansion phase of a business
cycle, the budget deficit declines.
2) As the expansion slows the budget
deficit increases and it continues to
increase during the recession.
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-42
The Business Cycle
and the Budget Deficit
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-43
The Business Cycle
and the Budget Deficit
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-44
Fiscal Policy Multipliers
Cyclical and Structural Balances
The Cyclically Adjusted Deficit
• The budget deficit that would occur if the
economy were at full employment and real
GDP equaled potential.
• Measures whether the deficit is cyclical or
structural (cyclically adjusted).
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-45
Fiscal Policy Multipliers
Cyclical and Structural Balances (cont.)
The Cyclically Adjusted Deficit
• The deficit is cyclical only if real GDP is below
potential GDP.
• A structural (cyclically adjusted) deficit exists if
real GDP equals potential GDP.
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-46
Expenditures, tax revenues and budget deficit
(trillions of 1992 dollars)
Cyclical and Structural Deficits
y*
Tax revenues
2.0
Cyclical deficit
and surplus
1.5
Cyclical
deficit
Cyclical
surplus
1.4
Expenditures
0
5
6
7
8
9
Real GDP (trillions of 1992 dollars)
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-47
Expenditures, tax revenues and budget deficit
(trillions of 1992 dollars)
Cyclical and Structural Deficits
y0*
y1*
y2*
2.0
Tax revenues
Structural deficit
and surplus
1.5
Structural
deficit
Structural
surplus
1.4
Expenditures
0
5
6
7
8
9
Real GDP (trillions of 1992 dollars)
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-48
Learning Objectives
• Define and explain the fiscal policy
multipliers
• Explain the effects of fiscal policy in both
the short run and the long run
• Distinguish between and explain the
demand-side and supply-side effects of
fiscal policy
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-49
Fiscal Policy Multipliers
and the Price Level
Fiscal Policy and Aggregate Demand
We will use the aggregate demand-aggregate
supply model to study the changes in real GDP
and the price level that result from fiscal policy.
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-50
Aggregate planned expenditure
(trillions of 1992 dollars)
Government Purchases
and Aggregate Demand
o
10
45 line
An increase in
government purchases...
AE1
AE0
b
9
8
…has a
multiplier
effect...
7
0
a
7
8
9
10
Real GDP (trillions of 1992 dollars)
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-51
Government Purchases
and Aggregate Demand
Price level
(GDP deflator, 1992 = 100)
150
130
110
b
a
…that increases
aggregate
demand and
shifts the AD
curve rightward
90
AD1
AD0
0
7
8
9
10
Real GDP (trillions of 1992 dollars)
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-52
Fiscal Policy Multipliers
and the Price Level
Fiscal Policy and Aggregate Demand
Expansionary fiscal policy is an increase in
government purchases or a decrease in taxes.
However, the distance of the AD curve shifts
is smaller for a tax cut than for a government
purchases increase of the same size.
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-53
Fiscal Policy Multipliers
and the Price Level
Fiscal Policy and Aggregate Demand
Contractionary fiscal policy is a decrease in
government purchases or an increase in taxes.
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-54
Learning Objectives
• Define and explain the fiscal policy
multipliers
• Explain the effects of fiscal policy in both
the short run and the long run
• Distinguish between and explain the
demand-side and supply-side effects of
fiscal policy
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-55
Fiscal Policy Multipliers
and the Price Level
Equilibrium GDP and the Price Level in the
Short Run
• Government purchases shift the aggregate
demand curve.
• In the short run, this brings about a change in
both the price level and real GDP.
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-56
Fiscal Policy, Real GDP,
and the Price Level
Price level
(GDP deflator, 1992 = 100)
150
SAS
130
126
110
c
a
90
0
b
AD0
7
8
AD1
8.6 9
Real GDP (trillions of 1992 dollars)
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-57
Fiscal Policy Multipliers
and the Price Level
Fiscal Expansions at Potential GDP
What happens if the government mistakenly
believes that the unemployment rate exceeds
the natural rate and uses expansionary fiscal
policy to try to reduce the unemployment rate?
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-58
Fiscal Policy, Real GDP, and the Price Level
Price level
(GDP deflator, 1992 = 100)
150
LAS
a'
SAS1
c
130
126
SAS0
Fiscal policy
with full
unemployment
employment
a
110
AD1
90
AD0
0
7
8
8.6 9
Real GDP (trillions of 1992 dollars)
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-59
Fiscal Policy Multipliers
and the Price Level
Limitations of Fiscal Policy
1) The legislative process is slow.
2) It is not always easy to tell whether real
GDP is below (or above) potential GDP.
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-60
Fiscal Policy and
Aggregate Supply
Fiscal Policy and Potential GDP
• Taxing people’s incomes when they work or
save weakens the incentives to work and save.
The quantity of labor and capital decreases which
lowers potential GDP.
• A group of economists, supply-siders, believe
that tax cuts strengthen incentives and increase
aggregate supply.
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-61
Fiscal Policy and
Aggregate Supply
Fiscal Policy and Potential GDP
• The income tax weakens the incentive to
develop new technologies.
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-62
Real wage rate (dollars per hour)
Supply-Side Effects of the Income Tax
LS+tax
LS
Income
tax
15
14
10
0
The Labor Market
LD
210 230
Quantity of labor (billions of hours per year)
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-63
Real interest rate (percent per year)
Supply-Side Effects of the Income Tax
KS+tax
KS
Income
tax
6
The Capital Market
5
4
KD
0
13
14
Quantity of capital (trillions of 1992 dollars)
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-64
Fiscal Policy and
Aggregate Supply
Supply Effects and Demand Effects
• A tax cut increases both aggregate supply and
aggregate demand.
• There is disagreement about which effect is
larger.
• A tax cut increases real GDP, but it can either
raise or lower the price level.
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-65
Two Views of the Supply-Side
Effects of Fiscal Policy
Price level (GDP deflator)
150
The Traditional View
SAS0
SAS1
115
110
Fiscal policy has a large
effect on AD and a small
supply-side effect
90
AD1
AD0
0
7
8
8.8 9
10
Real GDP (trillions of 1992 dollars)
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-66
Price level (GDP deflator)
Two Views of the Supply-Side
Effects of Fiscal Policy
150
The Supply-side View
SAS0
130
SAS1
110
Fiscal policy has a large
effect on AD and a large
supply-side effect
90
AD1
AD0
0
7
8
9
10
Real GDP (trillions of 1992 dollars)
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-67
The End
Copyright © 2000 Addison Wesley Longman, Inc.
Slide 13-68