Transcript Chapter 9 Fiscal Policy and the Public Debt

Chapter 9
Fiscal Policy and the
Public Debt
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
9-1
Learning Objectives
• Briefly outline the nature of federal
government expenditures and
revenues.
• Explain how a degree of economic
stability is built into our tax system.
• Survey some basic problems in the
application of fiscal policy.
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PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
9-2
Learning Objectives (cont.)
• Briefly discuss several contrasting budget
philosophies.
• Assess the quantitative and qualitative
aspects of the public debt.
• Discuss the implications of and
complications associated with fiscal policy
within the aggregate demand–aggregate
supply framework
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Federal Government
Finance
• Federal expenditures
–
large expenditure on social security and welfare
–
specific purpose grants
• Federal revenues
–
Personal income tax
–
Company income tax
–
Indirect and other taxes

sales tax

excise tax
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Discretionary Fiscal Policy
• The deliberate manipulation of taxes
and spending by government for the
purpose of altering real GDP and
employment, controlling inflation and
stimulating economic growth
• Not all fiscal policy is deliberate
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Expansionary Fiscal Policy
• If budget is initially balanced, moves it
towards a budget deficit during
recession
• Increased government spending
and/or lower taxes
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Contractionary Fiscal
Policy
• If budget is initially balanced, moves it
towards a budget surplus during an
inflationary period
• Decreased government spending
and/or higher taxes
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9-7
Financing Deficits
• Effect of expansionary fiscal policy
depends on method by which the
deficit is financed
–
Borrowing: May increase interest rates, thus
‘crowding out’ some investment
–
Money creation:

Deficit financed by the RBA by issuing new money

Avoids crowding out private spending
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9-8
Disposing of Surpluses
• Effect of contractionary fiscal policy
depends on method by which the
surplus (or movement towards
surplus) is financed
Debt reduction: May reduce anti-inflationary
impact of policy by reducing interest rates,
thereby stimulating private spending
– Idle surplus (or impounding): Government
withholds purchasing power
–
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Non-Discretionary Fiscal
Policy
• Built-in stabilisers that operate without
requiring explicit action by policy-makers
• During recessions: Tend to increase
government deficits (or reduce surplus)
• During inflationary periods: Tend to
increase government surpluses (or reduce
deficits)
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9-10
Automatic or Built-in
Stabilisers
• Tax receipts: Increase as real GDP increases
• Transfers: Decrease as real GDP increases
• Do not correct; only reduce the severity of
fluctuations
• Useful when economy is operating around
full employment
• Can cause problems: Fiscal Drag
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Slides prepared by Muni Perumal, University of Canberra, Australia
9-11
T
{
Government expenditure
and tax revenue
Built-in Stabilisers
Deficit
{
GDP3
GDP1
Surplus
G
GDP2
Real GDP (billions)
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Fiscal Drag
• Occurs when an economy stabilises at
an undesirable output level because of
the operation of automatic stablisers
• Over time as an economy grows, this
can choke off growth
• Cure: Discretionary fiscal policy
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A Government’s Fiscal
Stance
• Difficult to judge. Why?
• Actual budget surpluses or deficits in
any given year do not necessarily
indicate the government’s true fiscal
stance. Why?
• Built-in stability
• Solution: Cyclically adjusted budget
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Cyclically Adjusted Budget
• Indicates what the budget deficit (or
surplus) would be if the economy
were to operate at potential output
throughout the year
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Problems with Fiscal
Policy in Practice
• Problems of timing
–
–
–
Recognition lags
Administrative lags
Operational lags
• Political problems
–
–
–
Other economic goals: not just stability
Expansionary bias
A political business cycle
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Problems with Fiscal
Policy in Practice (cont.)
• Crowding-out effect
–
When an expansionary fiscal policy tends
to increase the interest rate, thus
reducing interest-sensitive private
spending, especially investment
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Managing Public Debt:
Various Philosophies
• Annually balanced budget
–
Pro-cyclical: intensifies recession or inflation
• Cyclically balanced budget
–
Counter-cyclical
–
Not annually balanced
–
Problem: upswings and downswings may not be
of equal magnitude
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Managing Public Debt:
Various Philosophies
(cont.)
• Functional finance
–
Primary purpose is to balance the economy, not
the budget
–
The problems of continuing annual deficits (or
surpluses) may be small compared to the
alternative: recession and high unemployment
(inflation)
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Public Debt
• The total accumulation of the Federal
Government’s total deficits and surpluses
over time
Myths about public debt:
• Government is going bankrupt
–
–
Government can refinance existing debt
Can create more money
• Shifting burdens, future generations will
pay for it
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Problems with Public Debt
Economic implications
• External debt may be a problem
• Increased taxes may dampen incentives
• Income distribution
–
Government bonds are generally held by those wealthier
members of society
• Composition important: capital versus
consumer goods
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Problems with Public Debt
(cont.)
Crowding-out and the stock of capital
• Future generations inherit a smaller
stock of capital goods due to the
crowding-out effect, which increases
interest rates and so reduces
investment spending
• Two qualifications
–
–
Public investment
Unemployment
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9-22
Public Debt: Positive Role
• Debt creation transfers saving to
spenders and thereby may play a
positive function in maintaining a high
level of output and employment
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Inflation and Fiscal Policy
• Some portion of the potential effect of
an expansionary fiscal policy on real
output and employment may be
dissipated in the form of inflation
• The effect of fiscal policy on inflation
affects net exports through the
foreign purchases effect
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No Crowding-Out Effect
ASLS
AS
Price level
AD1
P3
P2
P1
AD2
Q1
Q2
AD3
Qp
Real gross domestic product
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Crowding-Out Effect
AS
Price level
ASLS
AD1
P3
P2
P1
AD2
Q1
AD3
Q2 Qp
Real gross domestic product
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PPTs t/a Macroeconomics 7/e by Jackson and McIver
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Fiscal Policy and the Open
Economy
• The effectiveness of fiscal policy can
be altered by international conditions:
–
Shocks from abroad: small economies are
susceptible to international shocks that can alter
our GDP and render our fiscal policies
inappropriate
–
Net export effect
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Net Export Effect
• The impact of interest rate-induced
change in the exchange rate, and thus
net exports, following changes in
fiscal policy
–
Expansionary fiscal policy results in higher
interest rates resulting in increased demand for
$A resulting in appreciation of $A resulting in a
decline in net exports
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Net Export Effect (cont.)
–
Contractionary fiscal policy results in lower
interest rates resulting in decreased demand for
$A resulting in depreciation of $A resulting in an
increase in net exports
• Reduces the overall impact of fiscal
policy
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PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
9-29
Fiscal Policy and
Aggregate Supply
• Fiscal policy, especially tax changes, affects
not only aggregate demand but can affect
aggregate supply
• Tax changes in the form of incentives to
businesses and individuals can lead to a
rightward shift in the AS, providing a
further stimulus to the economy in terms of
lower prices and higher GDP
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Slides prepared by Muni Perumal, University of Canberra, Australia
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Supply-Side Effect of Fiscal Policy
Price level
AD1
P3
ASLS
AS1
AS2
P2
=
P1
AD2
Q1 Q2 Q3 Qp
Real gross domestic product
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
9-31
Next Chapter:
Money, Banking and the
Financial System
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia
9-32