Transcript Essentials of Economics, Krugman Wells Olney

Prepared by:
Fernando & Yvonn Quijano
© 2007 Worth Publishers Essentials of Economics Krugman • Wells • Olney
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The Akashi Kaikyo Bridge was built by
the Japanese government in the 1990s to
prop up aggregate demand.
What you will learn in
this chapter:
➤ What fiscal policy is and why it is an
important tool in managing economic
fluctuations
➤ Which policies constitute an expansionary
fiscal policy and which constitute a
contractionary fiscal policy
➤ Why fiscal policy has a multiplier effect and
how this effect is influenced by automatic
stabilizers
➤ Why governments calculate the cyclically
adjusted budget balance
➤ Why a large public debt may be a cause
for concern
➤ Why implicit liabilities of the government
are also a cause for concern
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Fiscal Policy: The Basics
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Fiscal Policy: The Basics
Taxes, Purchases of Goods and Services,
Government Transfers, and Borrowing
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Fiscal Policy: The Basics
Taxes, Purchases of Goods and Services,
Government Transfers, and Borrowing
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Fiscal Policy: The Basics
Taxes, Purchases of Goods and Services,
Government Transfers, and Borrowing
Social insurance programs are
government programs intended to protect
families against economic hardship.
The Government Budget and Total Spending
(17-1) GDP = C + I + G + X - IM
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Fiscal Policy: The Basics
Expansionary and Contractionary Fiscal Policy
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Fiscal Policy: The Basics
Expansionary and Contractionary Fiscal Policy
Expansionary fiscal policy increases
aggregate demand.
Fiscal policy that increases aggregate demand
normally takes one of three forms:
■ An increase in government purchases of goods
and services, such as the Japanese government’s
decision to launch a massive construction program
■ A cut in taxes, such as the one the United States
implemented in 2001
■ An increase in government transfers, such as
unemployment benefits
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Fiscal Policy: The Basics
Expansionary and Contractionary Fiscal Policy
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Fiscal Policy: The Basics
Expansionary and Contractionary Fiscal Policy
Contractionary fiscal policy reduces
aggregate demand.
A Cautionary Note: Lags in Fiscal Policy
Many economists caution against an extremely
active stabilization policy, arguing that a
government that tries too hard to stabilize the
economy—through either fiscal policy or monetary
policy—can end up making the economy less
stable.
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Fiscal Policy and the Multiplier
Multiplier Effects of an Increase in Government
Purchases of Goods and Services
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Fiscal Policy and the Multiplier
Multiplier Effects of Changes in Government Transfers
and Taxes
Expansionary or contractionary fiscal policy need
not take the form of changes in government
purchases of goods and services. Governments
can also change transfer payments or taxes.
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Fiscal Policy and the Multiplier
How Taxes Affect the Multiplier
A lump-sum tax does not change when
real GDP changes.
A proportional tax increases when real
GDP increases and decreases when real
GDP decreases.
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Fiscal Policy and the Multiplier
How Taxes Affect the Multiplier
Automatic stabilizers are government
spending and taxation rules that cause
fiscal policy to be expansionary when the
economy contracts and contractionary
when the economy expands.
Discretionary fiscal policy is fiscal policy
that is the result of deliberate actions by
policy makers rather than of rules.
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economics in action
How Much Bang for the Buck?
TABLE 17-1
Differences in the Effect of Expansionary Fiscal Policies
Estimated increase
in real GDP per
dollar of fiscal
policy)
Policy
Explanation of policy
Extend emergency federal
$1.73
Extends the period for unemployment benefits,
unemployment insurance benefits
increasing transfers to the unemployed
10% personal income tax bracket
1.34
Reduces tax rate on some income from 15% to
10%, mainly benefiting middle-income families
State government aid
1.24
Provides financial aid to state governments during
recessions so states do not have to raise taxes or
cut spending
Child tax credit rebate
1.04
Increases the income tax reduction for each child,
mainly benefiting middle- and lower-income
families
Marriage tax penalty
0.74
Reduces the “marriage penalty,” an increase in
combined taxes that can occur when two working
people marry
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economics in action
How Much Bang for the Buck?
TABLE 17-1 (cont’d.)
Differences in the Effect of Expansionary Fiscal Policies
Policy
Alternative minimum tax
adjustments
Personal marginal tax rate
reductions
Business investment writeoff
Dividend–capital gain tax
reduction
Estate tax reduction
Estimated increase
in real GDP per
dollar of fiscal
policy)
Explanation of policy
0.67
Revises the alternative minimum tax, designed to
prevent wealthy people with many deductions
from paying too little tax, to exclude those not
considered sufficiently wealthy
0.59
Reduces tax rates for people in higher income
brackets
0.24
Temporarily allows companies to deduct some
investment spending from taxable profits
0.09
Reduces taxes on dividends and capital gains
0.00
Reduces the tax paid on the value of assets
passed to heirs upon a person’s death
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The Budget Balance
The Budget Balance as a Measure of Fiscal Policy
The budget balance is the difference
between tax revenue and government
spending.
The budget surplus is the difference
between tax revenue and government
spending when tax revenue exceeds
government spending.
The budget deficit is the difference
between tax revenue and government
spending when government spending
exceeds tax revenue.
(17-2) Budget Balance = T – G – TR
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The Budget Balance
The Business Cycle and the Cyclically Adjusted
Budget Balance
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The Budget Balance
The Business Cycle and the Cyclically Adjusted
Budget Balance
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The Budget Balance
The Business Cycle and the Cyclically Adjusted
Budget Balance
The cyclically adjusted budget balance
is an estimate of what the budget balance
would be if real GDP were exactly equal
to potential output.
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The Budget Balance
The Business Cycle and the Cyclically Adjusted
Budget Balance
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The Budget Balance
Should the Budget Be Balanced?
Most economists don’t think so. They believe that
the government should only balance its budget on
average—that it should be allowed to run deficits
in bad years, offset by surpluses in good years.
Yet policy makers concerned about excessive
deficits sometimes feel that rigid rules
prohibiting—or at least setting an upper limit on—
deficits are necessary.
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Long-Run Implications of Fiscal Policy
Deficits, Surpluses, and Debt
Fiscal years run from October 1 to
September 30 and are named by the
calendar year in which they end.
Public debt is government debt held by
individuals and institutions outside the
government.
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Long-Run Implications of Fiscal Policy
Deficits, Surpluses, and Debt
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Long-Run Implications of Fiscal Policy
Problems Posed by Rising Government Debt
Crowding out is the negative effect of
budget deficits on private investment.
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Long-Run Implications of Fiscal Policy
Deficits and Debt in Practice
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Long-Run Implications of Fiscal Policy
Deficits and Debt in Practice
The debt–GDP ratio is government debt
as a percentage of GDP.
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Long-Run Implications of Fiscal Policy
Deficits and Debt in Practice
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Long-Run Implications of Fiscal Policy
Implicit Liabilities
Implicit liabilities are spending promises
made by governments that are effectively
a debt despite the fact that they are not
included in the usual debt statistics.
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Long-Run Implications of Fiscal Policy
Implicit Liabilities
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KEY TERMS
Social insurance
Budget surplus
Expansionary fiscal policy
Budget deficit
Contractionary fiscal policy
Cyclically adjusted budget balance
Lump-sum tax
Fiscal years
Proportional tax
Public debt
Automatic stabilizers
Crowding out
Discretionary fiscal policy
Debt–GDP ratio
Budget balance
Implicit liabilities
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