Transcript CHAPTER 9 The Government and Fiscal Policy

CHAPTER 9 The Government and Fiscal Policy
PowerPoint Lectures for
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Principles of
Macroeconomics, 9e
; ;
By
Karl E. Case,
Ray C. Fair &
Sharon M. Oster
Principles of Macroeconomics 9e by Case, Fair and Oster
1 of 39
CHAPTER 9 The Government and Fiscal Policy
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Principles of Macroeconomics 9e by Case, Fair and Oster
2 of 39
PART III THE CORE OF MACROECONOMIC THEORY
9
The Government
and Fiscal Policy
Prepared by:
Fernando & Yvonn Quijano
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Principles of Macroeconomics 9e by Case, Fair and Oster
PART III THE CORE OF MACROECONOMIC THEORY
The Government
and Fiscal Policy
9
CHAPTER OUTLINE
Government in the Economy
CHAPTER 9 The Government and Fiscal Policy
Government Purchases (G), Net Taxes (T),
and Disposable income (Yd)
The Determination of Equilibrium Output
(Income)
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Fiscal Policy at Work: Multiplier Effects
The Government Spending Multiplier
The Tax Multiplier
The Balanced-Budget Multiplier
The Federal Budget
The Budget in 2007
Fiscal Policy Since 1993: The Clinton and
Bush Administrations
The Federal Government Debt
The Economy’s Influence on the
Government Budget
Tax Revenues Depend on the State of the
Economy
Some Government Expenditures Depend on the
State of the Economy
Automatic Stabilizers
Fiscal Drag
Full-Employment Budget
Looking Ahead
Appendix A: Deriving the Fiscal Policy
Multipliers
Appendix B: The Case in Which Tax Revenues
Depend on Income
Principles of Macroeconomics 9e by Case, Fair and Oster
4 of 39
The Government and Fiscal Policy
CHAPTER 9 The Government and Fiscal Policy
fiscal policy The government’s spending and
taxing policies.
monetary policy The behavior of the Federal
Reserve concerning the nation’s money supply.
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Principles of Macroeconomics 9e by Case, Fair and Oster
5 of 39
Government in the Economy
CHAPTER 9 The Government and Fiscal Policy
discretionary fiscal policy Changes in taxes or
spending that are the result of deliberate changes
in government policy.
Government Purchases (G), Net Taxes (T), and Disposable
Income (Yd)
net taxes (T) Taxes paid by firms and households
to the government minus transfer payments made
to households by the government.
disposable, or after-tax, income (Yd) Total
income minus net taxes: Y - T.
disposable income ≡ total income − net taxes
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Yd ≡ Y − T
Principles of Macroeconomics 9e by Case, Fair and Oster
6 of 39
Government in the Economy
Government Purchases (G), Net Taxes (T), and Disposable
Income (Yd)
CHAPTER 9 The Government and Fiscal Policy
 FIGURE 9.1 Adding Net
Taxes (T) and Government
Purchases (G) to the
Circular Flow of Income
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Principles of Macroeconomics 9e by Case, Fair and Oster
7 of 39
Government in the Economy
Government Purchases (G), Net Taxes (T), and Disposable
Income (Yd)
CHAPTER 9 The Government and Fiscal Policy
When government enters the picture, the
aggregate income identity gets cut into three
pieces:
Yd  Y  T
Yd  C  S
Y  T  C S
Y  C S  T
And aggregate expenditure (AE) equals:
AE  C  I  G
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Principles of Macroeconomics 9e by Case, Fair and Oster
8 of 39
Government in the Economy
Government Purchases (G), Net Taxes (T), and Disposable
Income (Yd)
CHAPTER 9 The Government and Fiscal Policy
budget deficit The difference between what a
government spends and what it collects in taxes in
a given period: G - T.
budget deficit ≡ G − T
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Principles of Macroeconomics 9e by Case, Fair and Oster
9 of 39
Government in the Economy
Government Purchases (G), Net Taxes (T), and Disposable
Income (Yd)
CHAPTER 9 The Government and Fiscal Policy
Adding Taxes to the Consumption Function
To modify our aggregate consumption function to
incorporate disposable income instead of beforetax income, instead of C = a + bY, we write
C = a + bYd
or
C = a + b(Y − T)
Our consumption function now has consumption
depending on disposable income instead of
before-tax income.
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Principles of Macroeconomics 9e by Case, Fair and Oster
10 of 39
Government in the Economy
Government Purchases (G), Net Taxes (T), and Disposable
Income (Yd)
CHAPTER 9 The Government and Fiscal Policy
Planned Investment
The government can affect investment behavior
through its tax treatment of depreciation and other
tax policies.
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Principles of Macroeconomics 9e by Case, Fair and Oster
11 of 39
Government in the Economy
The Determination of Equilibrium Output (Income)
Y=C+I+G
CHAPTER 9 The Government and Fiscal Policy
TABLE 9.1 Finding Equilibrium for I = 100, G = 100, and T = 100
(1)
Output
(Income)
Y
300
500
700
900
1,100
1,300
1,500
(2)
(3)
(4)
(5)
Net
Disposable
Consumption
Saving
Taxes
Income
Spending
S
T
Yd / Y  T (C = 100 + .75 Yd) (Yd – C)
100
100
100
100
100
100
100
200
400
600
800
1,000
1,200
1,400
250
400
550
700
850
1,000
1,150
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
 50
0
50
100
150
200
250
(6)
(7)
Planned
Investment Government
Spending
Purchases
I
G
100
100
100
100
100
100
100
100
100
100
100
100
100
100
(8)
(9)
(10)
Planned
Aggregate
Expenditure
C+I+G
Unplanned
Inventory
Change
Y  (C + I + G)
Adjustment
to Disequilibrium
450
600
750
900
1,050
1,200
1,350
 150
 100
 50
0
+ 50
+ 100
+ 150
Output8
Output8
Output8
Equilibrium
Output9
Output9
Output9
Principles of Macroeconomics 9e by Case, Fair and Oster
12 of 39
Government in the Economy
The Determination of Equilibrium Output (Income)
CHAPTER 9 The Government and Fiscal Policy
 FIGURE 9.2 Finding Equilibrium
Output/Income Graphically
Because G and I are both fixed
at 100, the aggregate
expenditure function is the new
consumption function displaced
upward by I + G = 200.
Equilibrium occurs at Y = C + I +
G = 900.
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Principles of Macroeconomics 9e by Case, Fair and Oster
13 of 39
Government in the Economy
The Determination of Equilibrium Output (Income)
The Saving/Investment Approach to Equilibrium
saving/investment approach to equilibrium:
CHAPTER 9 The Government and Fiscal Policy
S+T=I+G
To derive this, we know that in equilibrium,
aggregate output (income) (Y) equals planned
aggregate expenditure (AE). By definition, AE
equals C + I + G; and by definition, Y equals
C + S + T. Therefore, at equilibrium
C+S+T=C+I+G
Subtracting C from both sides leaves:
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
S+T=I+G
Principles of Macroeconomics 9e by Case, Fair and Oster
14 of 39
Fiscal Policy at Work: Multiplier Effects
At this point, we are assuming that the government
controls G and T. In this section, we will review
three multipliers:
CHAPTER 9 The Government and Fiscal Policy
Government spending multiplier
Tax multiplier
Balanced-budget multiplier
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Principles of Macroeconomics 9e by Case, Fair and Oster
15 of 39
Fiscal Policy at Work: Multiplier Effects
The Government Spending Multiplier
government spending multiplier 
1
CHAPTER 9 The Government and Fiscal Policy
MPS
government spending multiplier The ratio of the
change in the equilibrium level of output to a
change in government spending.
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Principles of Macroeconomics 9e by Case, Fair and Oster
16 of 39
Fiscal Policy at Work: Multiplier Effects
The Government Spending Multiplier
TABLE 9.2 Finding Equilibrium After a Government Spending Increase of 50 (G Has
Increased from 100 in Table 9.1 to 150 Here)
CHAPTER 9 The Government and Fiscal Policy
(1)
Output
(Income)
Y
(2)
(3)
(4)
(5)
(6)
Net
Disposable Consumption
Saving
Taxes
Income
Spending
S
T
Yd / Y  T (C = 100 + .75 Yd) (Yd – C)
(7)
Planned
Investment Government
Spending
Purchases
I
G
(8)
(9)
(10)
Planned
Unplanned
Aggregate
Inventory
Adjustment
Expenditure
Change
To
C + I + G Y  (C + I + G) Disequilibrium
300
100
200
250
 50
100
150
500
 200
Output8
500
100
400
400
0
100
150
650
 150
Output8
700
100
600
550
50
100
150
800
 100
Output8
900
100
800
700
100
100
150
950
 50
Output8
1,100
100
1,000
850
150
100
150
1,100
0
1,300
100
1,200
1,000
200
100
150
1,250
+ 50
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Equilibrium
Output9
Principles of Macroeconomics 9e by Case, Fair and Oster
17 of 39
Fiscal Policy at Work: Multiplier Effects
The Government Spending Multiplier
CHAPTER 9 The Government and Fiscal Policy
 FIGURE 9.3 The Government
Spending Multiplier
Increasing government spending by
50 shifts the AE function up by 50.
As Y rises in response, additional
consumption is generated.
Overall, the equilibrium level of Y
increases by 200, from 900 to
1,100.
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Principles of Macroeconomics 9e by Case, Fair and Oster
18 of 39
Fiscal Policy at Work: Multiplier Effects
The Tax Multiplier
CHAPTER 9 The Government and Fiscal Policy
tax multiplier The ratio of change in the
equilibrium level of output to a change in taxes.
 1 
 Y  (initial increase in aggregate expenditure)  

 MPS 
1 
MPC 


Y  (  T  MPC )  
  T  

 MPS 
 MPS 
tax multiplier  
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
 
MPC
MPS
Principles of Macroeconomics 9e by Case, Fair and Oster
19 of 39
Fiscal Policy at Work: Multiplier Effects
CHAPTER 9 The Government and Fiscal Policy
The Balanced-Budget Multiplier
balanced-budget multiplier The ratio of change
in the equilibrium level of output to a change in
government spending where the change in
government spending is balanced by a change in
taxes so as not to create any deficit. The
balanced-budget multiplier is equal to 1: The
change in Y resulting from the change in G and
the equal change in T are exactly the same size as
the initial change in G or T.
balanced-budget multiplier  1
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Principles of Macroeconomics 9e by Case, Fair and Oster
20 of 39
Fiscal Policy at Work: Multiplier Effects
The Balanced-Budget Multiplier
TABLE 9.3 Finding Equilibrium After a Balanced-Budget Increase in G and T of 200 Each
(Both G and T Have Increased from 100 in Table 9.1 to 300 Here)
CHAPTER 9 The Government and Fiscal Policy
(1)
Output
(Income)
Y
(2)
(3)
(4)
Net
Disposable
Consumption
Taxes
Income
Spending
T
Yd / Y  T (C = 100 + .75 Yd)
(5)
(6)
(7)
(8)
(9)
Planned
Investment
Spending
I
Government
Purchases
G
Planned
Aggregate
Expenditure
C+I+G
Unplanned
Inventory
Change
Y  (C + I + G)
Adjustment
To
Disequilibrium
500
300
200
250
100
300
650
 150
Output8
700
300
400
400
100
300
800
 100
Output8
900
300
600
550
100
300
950
 50
Output8
1,100
300
800
700
100
300
1,100
0
1,300
300
1,000
850
100
300
1,250
+ 50
Output9
1,500
300
1,200
1,000
100
300
1,400
+ 100
Output9
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Equilibrium
Principles of Macroeconomics 9e by Case, Fair and Oster
21 of 39
Fiscal Policy at Work: Multiplier Effects
The Balanced-Budget Multiplier
TABLE 9.4 Summary of Fiscal Policy Multipliers
CHAPTER 9 The Government and Fiscal Policy
Policy Stimulus
Multiplier
Government
spending
multiplier
Increase or decrease in the
level of government
purchases: ∆G
1
MPS
Tax multiplier
Increase or decrease in the
level of net taxes: ∆T
 MPC
MPS
Balanced-budget
multiplier
Simultaneous balanced-budget
increase or decrease in the
level of government purchases
and net taxes: ∆G = ∆T
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
1
Final Impact On
Equilibrium Y
G 
T 
1
MPS
 MPC
MPS
G
Principles of Macroeconomics 9e by Case, Fair and Oster
22 of 39
The Federal Budget
federal budget The budget of the federal
government.
CHAPTER 9 The Government and Fiscal Policy
The “budget” is really three different budgets.
First, it is a political document that dispenses
favors to certain groups or regions and places
burdens on others.
Second, it is a reflection of goals the government
wants to achieve.
Third, the budget may be an embodiment of some
beliefs about how (if at all) the government should
manage the macroeconomy.
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Principles of Macroeconomics 9e by Case, Fair and Oster
23 of 39
The Federal Budget
CHAPTER 9 The Government and Fiscal Policy
The Budget in 2007
TABLE 9.5 Federal Government Receipts and Expenditures, 2007 (Billions of Dollars)
Amount
Percentage Of Total
Receipts
Personal income taxes
1,162.1
43.5
Excise taxes and customs duties
99.9
3.7
Corporate income taxes
380.8
14.3
Taxes from the rest of the world
13.4
0.5
Contributions for social insurance
953.0
35.7
Interest receipts and rents and royalties
25.1
0.9
Current transfer receipts from business and persons
39.4
1.5
Current surplus of government enterprises
− 2.3
− 0.0
Total
2,671.4
100.0
Current Expenditures
Consumption expenditures
856.0
29.6
Transfer payments to persons
1,270.7
43.9
Transfer payments to the rest of the world
38.6
1.3
Grants-in-aid to state and local governments
377.5
13.1
Interest payments
302.4
10.5
Subsidies
46.7
1.6
Total
2,892.0
100.0
Net federal government saving—surplus (+) or deficit (−)
− 220.6
(Total current receipts − Total current expenditures)
Source: U.S. Department of Commerce, Bureau of Economic Analysis.
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Principles of Macroeconomics 9e by Case, Fair and Oster
24 of 39
The Federal Budget
The Budget in 2007
CHAPTER 9 The Government and Fiscal Policy
federal surplus (+) or deficit () Federal
government receipts minus expenditures.
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Principles of Macroeconomics 9e by Case, Fair and Oster
25 of 39
The Federal Budget
CHAPTER 9 The Government and Fiscal Policy
Fiscal Policy Since 1993: The Clinton and Bush Administrations
 FIGURE 9.4 Federal Personal Income Taxes as a Percentage of Taxable Income, 1993 I–2007 IV
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Principles of Macroeconomics 9e by Case, Fair and Oster
26 of 39
The Federal Budget
CHAPTER 9 The Government and Fiscal Policy
Fiscal Policy Since 1993: The Clinton and Bush Administrations
 FIGURE 9.5 Federal Government Consumption Expenditures as a Percentage of GDP and
Federal Transfer Payments and Grants-in-Aid as a Percentage of GDP, 1993 I–2007 IV
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Principles of Macroeconomics 9e by Case, Fair and Oster
27 of 39
The Federal Budget
CHAPTER 9 The Government and Fiscal Policy
Fiscal Policy Since 1993: The Clinton and Bush Administrations
 FIGURE 9.6 The Federal Government Surplus (+) or Deficit (–) as a Percentage of GDP,
1993 I–2007 IV
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Principles of Macroeconomics 9e by Case, Fair and Oster
28 of 39
The Federal Budget
The Federal Government Debt
CHAPTER 9 The Government and Fiscal Policy
federal debt The total amount owed by the
federal government.
privately held federal debt The privately held
(non-government-owned) debt of the U.S.
government.
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Principles of Macroeconomics 9e by Case, Fair and Oster
29 of 39
The Federal Budget
CHAPTER 9 The Government and Fiscal Policy
The Federal Government Debt
 FIGURE 9.7 The Federal Government Debt as a Percentage of GDP, 1993 I–2007 IV
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Principles of Macroeconomics 9e by Case, Fair and Oster
30 of 39
The Economy’s Influence on the Government Budget
Tax Revenues Depend on the State of the Economy
CHAPTER 9 The Government and Fiscal Policy
Tax revenue, on the other hand, depends on
taxable income, and income depends on the state
of the economy, which the government does not
completely control.
Some Government Expenditures Depend on the State of the
Economy
Transfer payments tend to go down automatically
during an expansion.
Inflation often picks up when the economy is
expanding. This can lead the government to spend
more than it had planned to spend.
Any change in the interest rate changes
government interest payments.
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Principles of Macroeconomics 9e by Case, Fair and Oster
31 of 39
The Economy’s Influence on the Government Budget
Some Government Expenditures Depend on the State of the
Economy
CHAPTER 9 The Government and Fiscal Policy
Fiscal Policy In 2008
Congress Approves
Economic-Stimulus Bill
Wall Street Journal
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Principles of Macroeconomics 9e by Case, Fair and Oster
32 of 39
The Economy’s Influence on the Government Budget
Automatic Stabilizers
CHAPTER 9 The Government and Fiscal Policy
automatic stabilizers Revenue and expenditure
items in the federal budget that automatically
change with the state of the economy in such a
way as to stabilize GDP.
Fiscal Drag
fiscal drag The negative effect on the economy
that occurs when average tax rates increase
because taxpayers have moved into higher
income brackets during an expansion.
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Principles of Macroeconomics 9e by Case, Fair and Oster
33 of 39
The Economy’s Influence on the Government Budget
Full-Employment Budget
CHAPTER 9 The Government and Fiscal Policy
full-employment budget What the federal
budget would be if the economy were producing at
the full-employment level of output.
structural deficit The deficit that remains at full
employment.
cyclical deficit The deficit that occurs because of
a downturn in the business cycle.
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Principles of Macroeconomics 9e by Case, Fair and Oster
34 of 39
CHAPTER 9 The Government and Fiscal Policy
REVIEW TERMS AND CONCEPTS
automatic stabilizers
balanced-budget multiplier
budget deficit
cyclical deficit
discretionary fiscal policy
disposable, or after-tax,
income (Yd)
federal budget
federal debt
federal surplus (+) or deficit (−)
fiscal drag
fiscal policy
full-employment budget
government spending
multiplier
monetary policy
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
net taxes (T)
privately held federal debt
structural deficit
tax multiplier
1. Disposable income Yd ≡ Y − T
2. AE ≡ C + I + G
3. Government budget deficit ≡ G − T
4. Equilibrium in an economy with
government: Y = C + I + G
5. Saving/investment approach to
equilibrium in an economy with
government: S + T = I + G
1
6. Government spending multiplier ≡
MPS
 MPC 

 MPS 
7. Tax multiplier ≡  
8. Balanced-budget multiplier ≡ 1
Principles of Macroeconomics 9e by Case, Fair and Oster
35 of 39
APPENDIX A
DERIVING THE FISCAL POLICY MULTIPLIERS
THE GOVERNMENT SPENDING AND TAX MULTIPLIERS
C  a  b(Y  T )
CHAPTER 9 The Government and Fiscal Policy
Y  C I  G
Y  a  b(Y  T )  I  G
Y  a  bY  bT  I  G
Y  bY  a  I  G  bT
Y (1 b)  a  I  G  bT
1
Y 
(a  I  G  bT )
1  b
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Principles of Macroeconomics 9e by Case, Fair and Oster
36 of 39
APPENDIX A
DERIVING THE FISCAL POLICY MULTIPLIERS
THE BALANCED-BUDGET MULTIPLIER
CHAPTER 9 The Government and Fiscal Policy
The balanced-budget multiplier is found by
combining the effects of government spending and
taxes:
increase in spending:
- decrease in spending:
= net increase in spending
G
C  T (MPC )
G  T (MPC )
In a balanced-budget increase, ΔG = ΔT; so we can
substitute:
net initial increase in spending:
ΔG − ΔG (MPC) = ΔG (1 − MPC)
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Principles of Macroeconomics 9e by Case, Fair and Oster
37 of 39
APPENDIX A
DERIVING THE FISCAL POLICY MULTIPLIERS
THE BALANCED-BUDGET MULTIPLIER
CHAPTER 9 The Government and Fiscal Policy
Because MPS = (1 − MPC), the net initial increase
in spending is:
ΔG (MPS)
 1 
We can now apply the expenditure multiplier 

MPS


to this net initial increase in spending:
 1 
Y  G(MPS ) 
  G
 MPS 
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Principles of Macroeconomics 9e by Case, Fair and Oster
38 of 39
APPENDIX B
THE CASE IN WHICH TAX REVENUES DEPEND ON INCOME
CHAPTER 9 The Government and Fiscal Policy
 FIGURE 9B.1 The Tax Function
Yd  Y  T
Yd  Y  (200 1 / 3Y )
Yd  Y  2001/ 3Y
C  100 .75Yd
C  100 .75(Y  200 1 / 3Y )
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Principles of Macroeconomics 9e by Case, Fair and Oster
39 of 39
APPENDIX B
THE CASE IN WHICH TAX REVENUES DEPEND ON INCOME
Y  C  I G
Y  100  .75(Y  200  1/ 3Y )  100  100
I
G
C
CHAPTER 9 The Government and Fiscal Policy
Y  100 .75Y  150 .25Y  100 100
Y  450 .5Y
.5Y  450
 FIGURE 9B.2 Different Tax
Systems
When taxes are strictly lump-sum (T =
100) and do not depend on income,
the aggregate expenditure function is
steeper than when taxes depend on
income.
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Principles of Macroeconomics 9e by Case, Fair and Oster
40 of 39
APPENDIX B
THE CASE IN WHICH TAX REVENUES DEPEND ON INCOME
THE GOVERNMENT SPENDING AND TAX MULTIPLIERS ALGEBRAICALLY
C  a  b(Y  T )
CHAPTER 9 The Government and Fiscal Policy
C  a  b(Y  T0  tY )
C  a  bY  bT0  btY
Y  a  bY  bT  btY  I  G
0
C
1
Y
(a  I  G  bT0 )
1  b  bt
1
1  b  bt
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Principles of Macroeconomics 9e by Case, Fair and Oster
41 of 39