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Chapter 12 – Government and Fiscal Policy
Read pages 245 – 262
I Government and the Economy
A) Government Purchases includes purchases
of goods and services produced by firms
as well as production by agencies
themselves.
1) Does not include transfer payments.
2) Federal+State+ Local was around
19.5% of GDP until dropping to 17%
recently.
B) Transfer Payments are the provision of aid
or money to an individual who is not
required to provide anything in exchange.
1) Not counted as part of government
expenditures since it ends up in consumers
hands and is part of consumer spending.
2) Rises in recessions and falls in
expansions.
3) Recently has been around 10% if GDP.
C) Taxes
1) Bulk of Federal Taxes come from
Income taxes and payroll taxes.
2) Bulk of State and local come from
property and sales taxes.
D) Budget Balance
1) A Budget surplus occurs if government
revenues exceed expenditures.
2) A budget deficit occurs if government
expenditures exceed revenues.
3) If the surplus is zero, we say the
government has a balanced budget.
E) The national debt is the sum of all past
federal deficits, minus any surpluses.
1) National debt as a percentage of GDP
peaked during World War II around 120%
and declined until 1980.
1) National debt recently has been around
55% which is somewhat below average
relative to other countries.
II The Use of Fiscal Policy To Stabilize the
Economy
A) Automatic Stabilizers are government
programs that tend to reduce fluctuations
in GDP automatically.
1) Income taxes.
2) Transfer payments
B) Discretionary Fiscal Policy Tools.
1) Changes in Government Purchases.
Directly stimulates demand.
2) Changes in Business Taxes – Investment
tax credits. Stimulates investment spending.
3) Changes in income taxes. Stimulates
consumer spending.
4) Changes in transfer payments. Stimulates
consumer spending.
C) Because price changes may result from a
change in fiscal policy, the net effect will be
less than the full multiplier effect.
III Issues in Fiscal Policy
There are difficulties in using fiscal policy for
economic stabilization.
A) Lags –
1) Recognition lag can be long for both types of
policy.
2) Implementation lag is long relative to monetary
policy.
3) Impact lag is short relative to monetary policy.
4) Automatic stabilizers minimize both the
recognition lag and the implementation lag since
the policies automatically adjust to economic
conditions.
B) Crowding Out
1) The tendency for an expansionary fiscal policy
to reduce other components of aggregate demand
is called crowding out.
2) Basic mechanism.
a) Expansionary fiscal policy will increase debt.
b) This drives up interest rates.
c) This leads to,
i) less investment,
ii) higher demand and lower supply for
dollars.
d) (ii) leads to higher exchange rate and thus
less exports.
C) Choice of Policy
1) Fiscal conservatives prefer spending cuts
during inflationary gaps and tax cuts during
recessionary gaps.
2) Fiscal liberals prefer tax increases during
inflationary gaps and spending increases
during recessionary gaps.
3) Supply-side economists prefer policies that
promote long-run aggregate supply growth.
4) Even when there is agreement on fiscal
policy (e.g. tax cuts) there is disagreement on
what form it should take.
D) The Impact of the National Debt
There are several common views about whether
the size of the national debt is a problem.
1) Assets and Liabilities. National debt
accounting fails to account for the governments
assets.
2) Size of the debt relative to GDP is what is
important, not the absolute size.
3) Government does not have to worry about
going bankrupt the way a private individual
does.
4) Deficits and the Issues of Burden Shifting.
a) Certainly the debt crowds out investment and
leads to a reduced future productive capacity.
b) There is greater controversy regarding whether
current consumption by the government hurts
future generations.
1) One group of economists claim it does not
since the current generation pays for it via an
opportunity cost.
2) Another group claims this is not true since the
current generation would have consumed
something else and further the future generation
has to pay for the interest thus costing them an
opportunity.