Transcript Highlights of Chapter #11 Fiscal Policy

CAN GOVERNMENT CURE A SICK
ECONOMY
WITH FISCAL POLICY?????
Government Shutdown
Averted- What’s the big Deal??
 What Happens if the Debt Ceiling Isn’t
Raised?
 When countries default on their debts, it
doesn’t work the same as when individuals
declare bankruptcy.
 In many cases, the default results in
restructuring, and the debt is repaid over a
longer period of time, or new terms are
hammered out, or some of it is forgiven (but
this doesn’t happen much for wealthy,
developed nations).
 What really happens when a country defaults
on its sovereign debt is that confidence in
that country’s assets is reduced.
What is Fiscal Policy Anyway?
Usually Countercyclical in nature
Deliberate changes in
government spending or taxing to
Achieve full employment
Control inflation
Encourage economic growth
Highlights of Chapter
Fiscal Policy
What tools can the federal government use
to alter macroeconomic outcomes?
Taxing and spending in a variety of
combinations.
Can Taxing and spending alterations ensure
full-employment?
What policy actions will help fight inflation/
deflation?
What are possible risks of government
intervention?
Where does the power to tax original
from?
Article I, Section 8, U.S.
Constitution
“The Congress shall have power to:
1789- “to lay and collect taxes, duties,
imposts, and excises, to pay the debts
and provide for the common defense
and general welfare of the United
States.” (clause 1)
1913- 16th Amendment allowed the
federal government to collect from
individuals…
Article I, Section 8, Clause 2
 To borrow money on the credit of the
United States.
Discretionary Decision by
Congress (discretionary spending)
Government can alter aggregate
demand by:
Give examples……………….
Purchasing more or fewer goods and
services
 Raising or lowering taxes
 Changing the level of income
transfers
Government gets serious about Aggregates in 40’s
Employment Act of 1946
After WWII…the unemployment issues
needed to be addressed.
“Employment Act of 1946 passed- commits
the Federal government to use all
practicable means, consistent with
the market system, to create
economic conditions under which there
will be…. employment opportunities,
including self-employment for those able,
willing, and seeking work, and to promote
maximum employment production, and
purchasing power.”
The Employment Act:
Commits Federal government to take
action through monetary and fiscal
policy to maintain economic
stability.
**** This charge has specifically
been assigned to the Federal
Reserve (sans the fiscal part)…
Quick review of branches
 Which branch
the law?
 Which branch
the law?
 Which branch
interprets the
of government enforces
of government makes
of government
law?
The Executive branch responsible for
fulfilling the PURPOSE of the ACT.
Advisory groups to President:
CEA (Council of Economic Advisors)
JEC (Joint Economic Committee of
Congress)
 Purpose is to Shift Aggregate
Demand either right or left…
depending on needs for stability.
Expansionary and Contractionary
Fiscal Policy: Changes in
Government Spending
If there is a recessionary gap
in panel (a), fiscal policy can
presumably increase
aggregate demand
Expansionary and Contractionary
Fiscal Policy: Changes in
Government Spending
If there is an inflationary gap,
fiscal policy can presumably
decrease aggregate demand
If suddenly you have more disposable
income – what can you do?
Spend
Keynes theory- If you receive
windfall – you will not
spend every penny.
Govt calculates your Marginal
Propensity to Consume.
(say 75% spend – 25%
save)
Paradox of Thrift throws this
out.
Save
Supply side believes if
business receives tax cut
– they will invest for
growth.
Key here is- reducing
marginal tax rate. (the
rate one pays on every
extra hour of work one
does.)
Rate low- incentive to work
greater.
Revenue for government ?
The Tax Cut Multiplier
Tax Cut
First round of spending:
Second round of spending:
More consumption
= MPC X tax cut
More saving
= MPS X tax cut
More income
More saving
More consumption
More income
Third round of spending:
More saving
More consumption
Cumulative change in
saving: = tax cut
Government Going Into Debt!
If government year after year engages
in deficit spending… (more spending
less revenue)… then the national
debt will mount.
DUH!!! That’s the big controversy right
now… Will we spend ourselves into a
3rd world nation.
Government expenditures rise- taxes
remain the same- what has to give?
1.
2.
3.
4.
Government borrow the
difference.
Has to offer higher
interest rates to attract
takers
This is the interest rate
effect of expansionary
fiscal policy
When interest rates go
up, businesses less apt
to invest, consumers
less apt to purchase
interest sensitive g & s
Public Debt on Daily Report
 http://www.public
debt.treas.gov/
How does government pull this off?
 Borrowing from the public..
This is done by selling interest-bearing
bonds.*most likely will drive up interest rates and
“crowd out private investments. (*note this is
where foreign money is so important to
the U.S. government and can put us in
considerable peril if overdone)
**also note any decline in private
spending will weaken or reduce the
expansionary effect of deficit spending.
Figure 13-3 The CrowdingOut Effect, Step by Step
Remember Crowding Out
Government comes in and makes
financial investments so attractive
that it crowds out the private
sector…
Crowding out especially bad if near full
employment.
The big-time investor will want to seek
the best rate of return, and anytime
government wants, they can make
that be the scenario.
Second way for government to overspend
 Money Creation
 The Central Bank creates new money and
private spending is not affected by
expansionary efforts of the fiscal aspects.
 **** this means that… Federal spending can
continue without disrupting private spending or
investment….Referred to monetizing the
debt.(more $$ in circulation – debt goes “poof.”)
 Print money to pay the bill!

**** Problem is it is very inflationary… (Too
many $$$ chasing too few goods)
Fiscal Policy in a Nutshell
 Congress is too slow to act (too little too
late)
 Crowding out effects (government
expenditure can initiate private
investment both positive and negative)
 Public Choice –politicians want reelection- expansionary = popular,
contractionary = not popular and
painful.
 Supply side –smaller government –
taxes and government spending affect
individual incentives to work.
What is the relationship between tax
receipts and GDP???
 Increased Taxes reduce consumer
spending… and aggregate demand…
 These reductions would be favored if
moving toward inflation… but
increases in spending would be
favored if economy is slumping.
 So… we have inflation
Unemployment ?
 What % of GDP does consumption
take up?
Debt Ownership
 http://www.gao.gov/special.pubs/lon
gterm/debt/debtbasics.html
So… answer this question!!
What is the limit for Congress to spend
in any given year?
Where does the limit come from?
Is it stationary or floating?
Is this a question that our current
government is faced with?????
What happens if the Fed pulls back and
decides to balance the budget?
Will a tax cut hurt or help the budget?
Does it matter who gets the tax cut?
Does it matter who gets the tax
increase?
How would the multiplier work here?
With an average per capita income of
$47,500, America ranks in the Top 10 in
the world.
 WHAT THE TOP 1%, 5%, 10%, 25% and 50%
MAKE IN AMERICA
Based on the Internal Revenue Service’s 2010 database
below, here’s how much the top Americans make:
 Top 1%: $380,354
 Top 5%: $159,619
 Top 10%: $113,799
 Top 25%: $67,280
 Top 50%: >$33,048
3 Basic Types of Taxes
 Progressive
(tax base increases – tax rate
increases)
 Regressive
(tax base increases – tax rate
decreases)
 Proportional (Flat)
(tax base increases – tax rate no
variance)
Who Decides?
Which type of tax is best/most fair/best
revenue?
Which is the better way to eliminate
recession and inflation?
(government spending or taxes)
The answer here is whether you want
big government or “smaller”
government.
Remember- Keynesian/Supply
Supply Side was promoted by Art Laffer
in Regan Administration –
Keynesian stimulus of AD was prevelent
until the early 70’s.
Government revenue is always the
bottom line.
Figure 13-5 Laffer Curve
Tax rates and
tax revenues
rise together
Tax revenues
are at a maximum
Tax rates and tax
revenues fall
together
Terms to Know
Automatic fiscal policy
a change in fiscal policy caused by the
state of the economy. (unemployed- pay
fewer taxes.)
Discretionary fiscal policy
a policy action initiated by an Act of
Congress
Expansionary fiscal policy
government should either increase its
purchases of g&s or cut its taxes. (causes
govt to borrow.)
Automatic Stabilizers
 Automatic or Built-In Stabilizers (
should these be changed today???)
 Changes in government spending and
taxation that occur automatically without
deliberate action of Congress
 The tax system
 Unemployment compensation
 Welfare spending
Discretionary Fiscal Policy in Practice:
Coping with Time Lags - Fiscal results
 Long – a policy designed to correct a
recession may not produce results until
the economy is experiencing inflation. (912 months)
 Variable in length – they can be from 1-3
years, and the timing of the desired effect
cannot be predicted. (unemployment)
 Because fiscal policy time lags tend to
be variable, policymakers have a
difficult time fine-tuning the economy.
3 Kinds of Taxes
 Progressive tax- = tax rate/GDP rises with
GDP.
 Proportional tax = average tax rate
remains constant as GDP rises.
 Regressive tax system = average tax rate
falls as GDP rises.
 The progressive tax system is greater
built-in stabilizer… BUT….proportional tax
will ultimately bring in more revenue
remember Laffer curve).
Axiom to remember….. Always!
Increased taxes reduce spending
and Aggregate Demand
Reductions in spending are
desirable when economy is
moving toward inflation
Or Increases in spending are
desirable when economy is
moving toward a slump.
http://www.dallasfed.org/research/eclett/2010/el1008.pdf
Can the Nation Stimulate Its Way to Prosperity?
Timing!!!!!
Often times the move either way for
Congress and/or Admin is slow to realize
Administrative lag….. Takes time to digest
all the fiscal data and decide what to
suggest.
Operational Lag…usually a 9 to 12 month
period before any fiscal move can actually
take affect in the real world… work
projects, money into economy… Congress
passing the Bill and lots of pork added.
Remember… Porkbarrelling!!!
Leading Indicators
1.
2.
3.
4.
5.
6.
7.
8.
9.
Average workweek
Initial claims for unemployment insurance.
New orders for consumer goods
Vendor preferences (delivery status)
New orders for capital goods
Building permits for houses
Stock prices
Money supply
Interest-rate spread(smaller difference between
short term and long term rates usually spells
decline of GDP)
10. Consumer expectations
If government reduces taxes and increases
spending… created budget deficit…*this is where
we are now
Deficit spending = use of borrowed
funds to finance government
expenditures that exceed tax
revenues
Budget Deficit= amt which govt
spending exceeds govt revenues
(specific time period)
Surplus= ………..
Discretionary and automatic spending.
Each year… Pres/Congress put together
budget blueprint for next fiscal year.
OMB and CBO…
Fiscal year for federal government = October
1
Cyclical Deficits = portion of budget deficit
attributable to unemployment or inflation
Structural Deficit = whatever does not fall
into cyclical falls into structural (created
deficits by works of Congress)
Let’s Talk about DEBT
Accumulation of Debt:
When Treasury borrows funds, it
issues treasury bonds. Treasury
bonds = promissory notes (IOUs)
issued by the U.S. Treasury.
Total stock of all outstanding bonds
represent national debt.
Who owns the Debt?
National Debt represents a liability as
well as an asset in the form of
bonds.
Liability – obligation to make future
payment : debt
Asset = anything having exchange
value in the marketplace is wealth
*National debt creates as much wealth
(for bond holders as liabilities for the
U.S. Treasury).
Actual Ownership of the Debt
 Federal Agencies hold roughly ?% of outstanding
Treasury Bonds
 Federal Reserve acquires Treasury bonds in its
conduct of monetary policy(now about 9%)
 SS Trust Fund is the largest owner of U.S. Debt
 State and local governments hold 7%
 All debt held by U.S. households, institutions and
governments is called internal debt and equals
approximately 88% of the total
 External debt- U.S. govt debt (Treasury bonds) held
by foreign households and institutions. ** this is
increasing ( now about 47%)
Debt Service
 This is the interest required to be paid
each year on outstanding debt.
 Paying interest on the debt restricts
government’s ability to balance the
budget or fund other public sectors
 Most debt servicing is a redistribution of
income from taxpayers to bondholders.
 Opportunity cost or burden of debt is the
OC of the activities financed by the debt
(what they could do with the money…in
the alternative)
WHAT CAN YOU DO?
Be cognizant of economic events
Don’t be an ostrich
VOTE FOR BEST CANDIDATE
Then appears the Elephant in
the Living Room
SOCIAL SECURITY::::::::::::
2010?
2015?
2030?
Where will you be in those years?
SS is funded from payroll taxes (then it is
assisted from the General Revenue Fund).
AND MEDICARE/MEDICAID