Transcript Macro Chapter 7 Lecture

SAYRE | MORRIS
Seventh Edition
CHAPTER 7
Fiscal Policy
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Fiscal Policy
Fiscal Policy
• Government’s approach toward its own spending
and taxation
• Minister of finance brings down annual budget in
Parliament each spring
• Contains estimates of government’s revenues and
expenditures
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Table 7.1
Federal Government Budget Year Ending March 2010
REVENUES
Personal income taxes
Corporate and other income taxes
E.I. premiums
GST and excise and energy taxes
Nontax revenues
Total Revenues
OUTLAYS
Transfers to persons
Spending grants to other levels of govt
Public debt charges
Direct program spending
Total Outlays
Projected Budget Plan Deficit
103.9
36.0
16.8
40.6
21.6
218.6
68.6
57.0
29.4
119.2
274.2
55.6
Source: Data derived by authors from information found in Department of Finance; Annual Report to the Government 2009-2010. Reproduced with the permission of the Minister
of Public Works and Government Services, 2010.
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Fiscal Policy
LO1
Net Tax Revenue
• total tax revenue received by government less
transfer payments
NTR = tax revenue  transfer payments
Budget Balance
• the difference between net tax revenues and
government spending
Budget Balance = NTR - G
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Fiscal Policy
Budget Surplus
• net tax revenue in excess of government spending on
goods and services
Budget Deficit
• government spending on goods and services in
excess of net tax revenues
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Fiscal Policy
National Debt
• the sum of the federal government’s budget deficits
less its surpluses
Balanced Budget
• the equality of net tax revenues and government
spending on goods and services
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Table 7.2
Net National Debt (current $ billion)
Year
1940
1963
1973
1983
1993
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
Budget Surplus
—
—
—
—
—
—
3.0
5.8
14.3
19.9
8.0
6.6
9.1
1.5
13.2
13.8
9.6
—
—
Budget Deficit
0.1
0.8
1.9
29.0
39.0
8.7
—
—
—
—
—
—
—
—
—
—
—
−5.8
−55.6
Net National Debt
3.3
15.7
24.0
136.7
449.0
562.9
559.9
554.1
539.9
520.0
511.9
505.3
496.2
494.7
481.5
467.3
457.6
463.7
519.1
Department of Finance: Fiscal Reference tables October 2010.
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Fiscal Policy
The government budget is affected by:
• the level of the GDP
• A change in the amount of government spending
• A change in the amount of government revenue
(taxation)
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Countercyclical Fiscal Policy
John Maynard Keynes:
• Developed model in response to the depression
• Based on aggregate expenditures:
AE = C + I + G + Xn
• Believed depression was caused by decreased
aggregate expenditures
• Argued for increased government expenditures to
increase employment and incomes
• Increased spending financed through borrowing
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Counter-Cyclical Fiscal Policy
Potential GDP
P
Dealing with a
recessionary gap:
- raise G and/or
lower T
- total spending
increases to AD2
- shifts economy
back to potential
GDP
AS1
G
Recessionary gap
AD2
AD1
Y1
YFE
Real Y
Chapter 11-12
LO2
Counter-Cyclical Fiscal Policy
Potential GDP
P
Dealing with an
inflationary gap:
- lower G and/or
raise T
- total spending
decreases to AD2
- shifts economy
back to potential
GDP
AS1
G
Inflationary gap
AD1
AD2
YFE
Y1
Real Y
Chapter 11-13
LO2
Countercyclical Fiscal Policy
Summary:
• When there is a recessionary gap, governments
should spend and tax in a way that increases
aggregate demand.
• When there is an inflationary gap, governments
should spend and tax in a way that reduces
aggregate demand.
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Countercyclical Fiscal Policy
Shortcomings:
• it is subject to serious time lags
• it has an inflationary bias
• it can cause serious budget deficits
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Balanced Budget Fiscal Policy
• the government budget is balanced in each fiscal
period
• addresses the shortcomings of a countercyclical
fiscal policy
• relies on automatic stabilizers (tax laws and
spending programs that cut back spending during a
boom and increase spending in a slowdown)
• based on belief that economy will return to full
employment on its own
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Balanced Budget Fiscal Policy
P
Potential GDP
AS1
 Wages
AS2
Recessionary gap
AD
Y1
YFE
Recessionary gap:
- eventually wages
will be forced down
-AS increases,
returning economy
to YFE
- also decreases
price level
AS would increase because we
know that when a productive
resource decreases (wages),
supply increases.
Real Y
Chapter 11-17
LO3
Balanced Budget Fiscal Policy
Shortcomings:
• Procyclical: pushing the economy further in the
same direction it is going
• balanced budget is procyclical in a recessionary
gap, because low tax revenues create deficits
• may be procyclical in an inflationary gap, if it is
accompanied by a budget surplus
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Cyclically Balanced Budget
Fiscal Policy
LO4
• the use of countercyclical fiscal policy to balance the
budget over the life of the business cycle
• no guarantee that size and length of recessionary
gap will be exactly offset by the size and length of the
inflationary gap
• most governments find it easier to increase spending
in bad times than to decrease it in good times
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LO5
Fiscal Policy and National Debt
• government borrows by issuing bonds
• debt held by individuals, corporations, and financial
institutions
• interest payments represent redistribution of wealth
from all taxpayers to relatively wealthy bondholders
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Fiscal Policy and National Debt
• debt increased significantly to finance WWII
• debt increased again since 1970s
• increase in income-support programs
• high interest rates in 1970s and 1990s
• since 1995, Canada’s debt fell to lowest of G8
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Fiscal Policy and National Debt
Problems with High Deficits / Debt:
• the interest payments that must be paid on the
foreign-held debt
• the income redistribution effects of large interest
payments
• the reduced ability of government to meet the needs
of its citizens
• the possible increased power grabbing and
wastefulness of government
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