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Fiscal Policy and the
Multiplier
Unemployment
Seasonally Adjusted Monthly Unemployment
Rate, from January 1984 to December 2004
Unemployment Rate
(%)
10
9
8
7
6
5
4
3
2
Ja
Ja
Ja
Ja
Ja
Ja
Ja
Ja
Ja
Ja
Ja
0
n-
0
n-
0
n-
9
n-
9
n-
9
n-
9
n-
9
n-
8
n-
8
n-
8
n-
4
2
0
8
6
4
2
0
8
6
4
Month
Economic Growth
Percentage Change in Real Gross Domestic
Product (1984-2004)
Percentage Change
8
7
6
5
4
3
2
1
0
04
20
02
20
00
20
98
19
Year
96
19
94
19
92
19
90
19
88
19
86
19
84
19
-1
CPI and PPI
Percentage Change in Consumer Price Index (Not
Seasonally Adjusted, 1982-84=100) and Implicit Price
Deflator (2000=100), 1984-2003
% change in CPI
% change in IPD
Percentage Change
6.00
5.00
4.00
3.00
2.00
1.00
0.00
02
20
00
20
98
19
96
19
94
19
92
19
90
19
88
19
86
19
84
19
Year
Income Determination
GDP = C + I + G + (X-M)
•CONSUMPTION
•INVESTMENT
•GOVERNMENT
•NET EXPORTS
Fiscal Policy
• Changes in government spending
and taxes to influence the level of
economic activity
– Increase taxes, contract the economy
– Decrease taxes, stimulate the
economy
– Increase government spending,
stimulate the economy
– Decrease government spending,
contract the economy
• President and Congress determine
fiscal policy
G or T?
• Changes in G have greater impact
on the economy than changes in
taxes.
– Government spending is direct
– Taxes depend on what consumers do
with the tax cut or what they would
have done with the money going to
pay the tax increase (how much would
they consume, how much would they
save?)
Crowding Out
• Government increases spending
• Finances it by borrowing in credit
market
• Interest rates go up
• Private investment falls
• Increased government spending is
offset by decreased private
investment
The Expenditure Multiplier
• There is a change in spending
• The change in spending becomes a
change in income for others
• Those changes in income become
spending
• The change in spending becomes a
change in income for others
• Etc.
Main Points
• Three macro goals
– Full employment, economic
growth, price stability
• Discretionary fiscal policy – the
use of changes in government
spending and taxes to
influence the level of
economic activity
Main Points
• Expenditure multiplier –
change in initial spending is
multiplied to cause greater
change in spending
• Changes in G have greater
impact than changes in T
Main Points
• Government deficit – spending
greater than taxes per year
• Government debt –
accumulated deficits
• Crowding out – government
spending financed by private
borrowing raises interest rates
and crowds out private
investment