Transcript Chapter 13 - WordPress.com

PowerPoint Presentation by
Mehdi Arzandeh, University of Manitoba
Fiscal Policy, Deficits,
Surpluses, and Debt
13
LEARNING OBJECTIVES
LO13.1
LO13.2
LO13.3
LO13.4
LO13.5
LO13.6
Identify and explain the purposes, tools, and limitations of fiscal policy.
Explain the role of built-in stabilizers in moderating business cycles.
Describe how the cyclically adjusted budget reveals the status of Canadian fiscal
policy.
Summarize recent Canadian fiscal policy and the projections for Canadian fiscal
policy over the next few years.
Discuss the problems that governments may encounter in enacting and applying
fiscal policy.
Discuss the size, composition, and consequences of the Canadian public debt.
© 2016 McGraw‐Hill Education Limited
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13.1
Fiscal Policy and the AD-AS
Model
• Since 1945, fiscal policy has been one of the government’s
main stabilization policy tools
• “active” if changes in government spending or taxes are at
the option of the government
• “non-discretionary” if independent of parliamentary action
LO1
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13.1
Fiscal Policy and the AD-AS
Model
• Expansionary Fiscal Policy
• Used when Recession Occurs
• Options:
• Increased Government Spending
• Tax Reductions
• Combined Government Spending Increases and Tax Reductions
May Create a Budget Deficit
LO1
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FIGURE 13-1
Expansionary Fiscal Policy
$5 billion
increase in
spending
Recessions
Decrease AD
Price level
AS
Full $20 billion
increase in
aggregate demand
P1
AD1
AD2
$490
$510
Real GDP (billions)
LO1
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13.1
Fiscal Policy and the AD-AS
Model
• Contractionary Fiscal Policy
• Used to Combat Demand-pull Inflation
• Options:
• Decreased Government Spending
• Increased Taxes
• Combined Government Spending Decreases and Tax
Increases
LO1
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FIGURE 13-2
Contractionary Fiscal Policy
$3 billion initial
decrease in
spending
Price level
AS
P2
P1
d
c
Full $12 billion
decrease in
aggregate demand
b
a
AD4
AD3
$502 $510
LO1
$522
AD5
Real GDP (billions)
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13.1
Fiscal Policy and the AD-AS
Model
• Policy Options: G or T?
• To expand the size of government
• If recession, then increase government spending
• If inflation, then increase taxes
• To reduce the size of government
• If recession, then decrease taxes
• If inflation, then decrease government spending
LO1
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13.2 Built-in Stability
• Net tax revenues vary directly with GDP
• Taxes rise when GDP rises, and vice versa
• Transfer payments fall when GDP rises, and vice versa
• Leads to automatic stabilization over the business
cycle.
LO2
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13.2 Built-in Stability
Automatic or Built-In Stabilizers
• A structure of taxation and spending that:
• Increases the deficit (reduces the surplus) during
recession
• Increases the surplus (reduces the deficit) during inflation
LO2
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13.2 Built-in Stability
ECONOMIC IMPORTANCE
• The stabilizers will automatically restrain economic
expansion and cushion economic contraction.
• Taxes reduce spending and aggregate demand.
• Reductions in spending are desirable when the economy is
developing inflationary pressures.
• Increases in spending are desirable when the economy is
slumping.
LO2
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FIGURE 13-3
Built-in Stability
Government expenditures, G,
and tax revenues, T
T
Surplus
G
Deficit
GDP1
GDP2
GDP3
Real domestic output, GDP
LO2
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13.2 Built-in Stability
TAX PROGRESSIVITY
The built-in stability depends on:
• Tax Progressivity
• Progressive
• Proportional
• Regressive
• The more progressive the tax system, the greater the
economy’s built-in stability
LO2
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13.3
Evaluating How Expansionary or
Contractionary Fiscal Policy Is Determined
•To evaluate fiscal policy stance, must
• Adjust deficits and surpluses to eliminate
automatic changes in tax revenues
• Compare adjusted budgets to GDP
LO3
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13.3
Evaluating How Expansionary or
Contractionary Fiscal Policy Is Determined
•Cyclically Adjusted Budget
• The cyclically adjusted budget shows what the
budget balance would be if the economy were
operating at full employment.
LO3
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FIGURE 13-4
Cyclically Adjusted Deficits
Government expenditures, G, and
tax revenues, T (billions)
T
a
b
G
$500
450
c
GDP2
(year 2)
LO3
GDP1
(year 1)
Real domestic output, GDP
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FIGURE 13-4
Cyclically Adjusted Deficits
Government expenditures, G, and
tax revenues, T (billions)
T1
T2
d
e
G
$500
475
450
425
h
f
g
GDP4
(year 4)
LO3
GDP3
(year 3)
Real domestic output, GDP
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13.4 Recent Canadian Fiscal Policy
• Neutral to mildly expansionary in the early 1990s
• Contractionary in late 1990s
• Between 1995 and 2007, actual deficits have given
way to actual surpluses
• In 2008, “Canada’s Economic Action Plan” and the
federal budget moved quickly to a deficit
• In 2009, expansionary fiscal policy
LO4
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TABLE 13-1
Federal Deficits (-) and Surpluses (+) as
Percentage of GDP, 2000-2013
(1) Year
(2) Actual deficit or surplus
(3) Cyclically adjusted deficit or surplus
2000
+1.4
+1.8
2001
+1.9
+1.1
2002
+0.7
+0.8
2003
+0.6
+1.2
2004
+0.7
+0.9
2005
+0.1
+0.9
2006
+0.9
+0.9
2007
+0.9
+0.5
2008
+0.6
0.0
2009
-0.3
-0.2
2010
-3.4
-0.8
2011
-1.9
-0.6
2012
-1.5
-0.9
2013
-1.0
-0.8
Source: Department of Finance Canada, 2013
LO4
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13.1 GLOBAL PERSPECTIVE
Cyclically Adjusted Budget Deficits and Surpluses as a
Percentage of Potential GDP, Selected Nations
LO4
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13.5
Problems, Criticisms, and Complications
of Implementing Fiscal Policy
• Problems of Timing
• Recognition Lag
• Administration Lag
• Operational Lag
• Political Considerations
• Future Policy Reversals
• Offsetting Provincial and Municipal Finance
LO5
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13.5
Problems, Criticisms, and Complications
of Implementing Fiscal Policy
• Crowding-Out Effect
Expansionary fiscal policy may lead to
• higher interest rates
• reduction in interest-sensitive spending
• May not be significant in a recession
• Fiscal policy can be accommodated by increases in money supply
LO5
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FIGURE 13-5
Fiscal Policy: The Effects of Crowding Out and the
Net Export Effect
Price level
With an upward-sloping
aggregate
AS
supply curve, a part of the impact of an
expansionary policy will be reflected in a
rise in the price level rather than an
increase in real output and
employment.
P1
P0
a
c
b
AD1
AD’1
AD0
0
GDP GDP1 GDPf
Real domestic output, GDP
LO5
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13.5
Problems, Criticisms, and Complications
of Implementing Fiscal Policy
Fiscal Policy in the Open Economy
• SHOCKS ORIGINATING FROM ABROAD
• Economies are open to unforeseen international aggregate demand
shocks
• e.g. Canadian Economy was affected by the turmoil in the US housing
and financial markets
• NET EXPORT EFFECT
LO5
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TABLE 13-2
LO5
Fiscal Policy and the Net Export Effect
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13.5
Problems, Criticisms, and Complications
of Implementing Fiscal Policy
Current Thinking on Fiscal Policy
• Most economists believe fiscal policy is a useful policy lever
• not for “fine-tuning”
• major discretionary fiscal policy should be held in reserve
• should be evaluated for impact on long-run productivity growth
LO5
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13.6
Deficits, Surpluses, and the
Federal Debt
Budget Surplus
• Annual amount by which government revenues exceed
government expenditures
Budget Deficit
• Annual amount by which government expenditures exceed
taxes
Public Debt
• Accumulation of all past deficits and surpluses
LO6
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13.6
Deficits, Surpluses, and the
Federal Debt
• Debt and GDP
• Relative size of the debt fell in the last decade but rose after 2009 Great
Recession again.
• International Comparisons
• Our debt is among lowest as % of GDP among world’s industrialized nations
• Interest Charges
• The primary burden of the debt is the annual interest charge
• Ownership
• About 80% of the total debt is held internally and about 20% of the gross
federal debt is held by foreigners.
LO6
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FIGURE 13-6
LO6
The Gross Federal Debt as a Percentage of GDP
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13.2 GLOBAL PERSPECTIVE
Publicly Held Debt: International Comparisons
LO6
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FIGURE 13-7
Ownership of Canada’s Gross Public Debt in 2011
Source: Adapted from Bank of Canada, Banking and Financial Statistics, April 2015. http://www.bankofcanada.ca/wpcontent/uploads/2015/04/bfs_april15.pdf , accessed May 27, 2015, and the Department of Finance, Fiscal Reference Tables
http://www.fin.gc.ca/afr-rfa/2014/report-rapport-eng.asp#toc5, accessed May 27, 2015.
LO6
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13.6
Deficits, Surpluses, and the
Federal Debt
Unfounded Concerns
• BANKRUPTCY
• Refinancing
• Taxation
• BURDENING FUTURE GENERATIONS
• Canada owes a substantial portion of the public debt to
itself
LO6
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13.6
Deficits, Surpluses, and the
Federal Debt
Substantive Issues
• INCOME DISTRIBUTION
• INCENTIVES
• FOREIGN-OWNED PUBLIC DEBT
• CROWDING OUT REVISITED
• Public Investments and Public-Private Complementarities
LO6
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FIGURE 13-8
The Investment Demand Curve and the CrowdingOut Effect
16
Real interest rate (percent)
14
12
b
10
8
a
6
Crowding-out
effect
4
ID2
2
ID1
0
LO6
c
Increase in
investment
demand
5
10 15 20 25 30
Investment (billions of dollars)
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The LAST
WORD
Federal and Provincial per
Capita Net Debt, 2014
Canada
$ 17,985
Quebec
19,924
Newfoundland and Labrador
16,094
Ontario
16,040
Nova Scotia
13,573
New Brunswick
12,748
Prince Edward Island
11,788
Manitoba
10,631
British Columbia
6.699
Saskatchewan
3,474
Alberta
-4,868
Source: Statistics Canada and the Department of Finance, 2011
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Chapter Summary
LO13.1
LO13.2
LO13.3
LO13.4
LO13.5
LO13.6
Identify and explain the purposes, tools, and limitations
of fiscal policy.
Explain the role of built-in stabilizers in moderating
business cycles.
Describe how the cyclically adjusted budget reveals the
status of Canadian fiscal policy.
Summarize recent Canadian fiscal policy and the
projections for Canadian fiscal policy over the next few
years.
Discuss the problems that governments may encounter
in enacting and applying fiscal policy.
Discuss the size, composition, and consequences of the
Canadian public debt.
© 2016 McGraw‐Hill Education Limited
13-36