Lecture 7. Fiscal Policy

Transcription

1 Lecture 7 Fiscal Policy

2 The role of government spending and taxes Fiscal policy: government spending and tax policy AD = C + II + G What if G changes? What is the effect on Y? How large is (government) spending multiplier: Y = 1 1 mpc G Y = mult G

3 An Increase in Government Spending

4 Aggregate Demand and Output An Increase in Government Spending 800 Full Employment E 1 AD 1 (G = 80) AD 0 (G = 0) Full Employment Equilibrium 400 E 0 (Unemployment Equilibrium) Y* Income (Y)

5 Taxes and transfer payments Transfer payments: Payments by governments to individuals or firms, including Social Security payments, unemployment compensation, and interest payments Disposable income: Income remaining for consumption or saving after subtracting taxes and adding transfer payments Y d = Y T + TR

6 Tax multiplier Lump-sum tax: a tax set at a fixed level that does not change with income, so that T = T Tax multiplier for lump-sum tax T: C = mpc T Y = mult C = mult mpc T Y T = mult mpc

7 Balanced budget multiplier What if G = T? What is the effect on Y? Balanced budget multiplier = 1. Why? Balanced budget multiplier = Spending multiplier + Tax multiplier = Y G + Y T = 1

8 Expansionary and contractionary fiscal policy Expansionary fiscal policy The use of government spending, transfer payments, or tax cuts to stimulate a higher level of economic activity Contractionary fiscal policy Reductions in government spending or transfer payments, or increases in taxes, leading to a lower level of economic activity

9 A Macroeconomic Model with Government Spending and Taxes Output (Y) Production generates income to households Income (Y) consumption (C) Spending (AD) Banks and Financial System Government

10 Budgets, deficits, and policy issues Government outlays: total government expenditures including spending on goods and services and transfer payments Government outlays (expenditures) = G + TR Government revenue = T Government budget = T (G + TR) If that s (+): Budget surplus If that s (-): Budget deficit

11 United States Government Source of Funds, 2011 Borrowing to cover deficit (36%) Personal income taxes (30%) Excise, estate, and other taxes (6%) Social insurance and retirement taxes (23%) Corporate taxes (5%)

12 United States Government Outlays, 2011 Justice, government administration (2%) Science, natural resources, transportation (5%) Health (10%) Interest on debt (6%) Social security, Medicare (33%) Income security, education, social services (20%) National defense, veterans, foreign affairs (24%)

13 Budget expenditures, Turkey, 2010

14 Budget revenues, Turkey, 2010

15 Percentage of GDP 10.0 Federal Surplus or Deficit as a Percent of GDP

16 Percent of GDP Federal Outlays, Receipts, and Surplus/Deficit, as a Percent of GDP, Outlays Receipts Surplus or Deficit Source: Economic Report of the President 2012, Table b-79.

17 Budget deficit (% of GDP), Turkey, Source:

18 Government debt (% of GDP) Source: OECD

19 Deficit vs debt Debt is a stock variable, deficit is flow variable Debt rises when government runs a deficit, falls when government runs a surplus Is government debt «good» or «bad»?

20 Automatic stabilizers Automatic stabilizers: Tax and spending institutions that tend to increase government revenues and lower government spending during economic expansions, but lower revenues and raise government spending during economic recessions

21 Discretionary fiscal policy Time lags can make active fiscal policy less effective: Inside lags Data lag Recognition lag Legislative lag Transmission lag Outside lags Supply-side economics: An economic theory that emphasizes policies to stimulate production, such as lower taxes. The theory predicts that such incentives stimulate greater economic effort, saving, and investment, thereby increasing overall economic output and tax revenues

22 Is a balanced budget always Potential problems: «good»? Difficult to respond to emergencies such as natural disasters Automatic stabilizers would be ineffective Discretionary fiscal policy would be ruled out

23 Interest Rate Crowding Out in the Loanable Funds Market S 10 Government Borrowing 8 i 2 6 i Q 3 Q 1 Q 2 D 1 D Crowding out Quantity of Loanable Funds

24 Multiplier with a proportional tax AD = C + mpc Y ty + TR + II + G The tax multiplier with a proportional tax is therefore: mult = 1 1 mpc(1 t)

25 Aggregate demand and output A Reduction in the Proportional Tax Rate AD 1 (decrease in t) E 1 AD 0 (original t) Slope = mpc(1 t) E 0 45 Y 0 Y 1 Income (Y)

26 The international sector AD = C + II + G + NX Multiplier effect for exports: Y = mult X 1 mult = 1 mpc Multiplier effect for imports is more complicated: 1 mult = 1 mpc 1 t + mpim

27 Output (Y) Production generates income to households Income (Y) leakages taxes (T) savings (S) consumption (C) Spending (AD) imports (IM) injections intended investment (II) government spending (G) exports (X)