Transcript Chapter 10
Chapter 10 Fiscal Policy What’s Fiscal Policy? ► Before we look at Fiscal Policy let’s take a look at the past. ► Big Idea The invisible hand doesn't always work Government needs to play an active role in the economy Counter Cyclical Spending Business cycle Keynesian School of Thought ► Believe that government intervention in economy ( ex. Public works projects, interest rates) could stimulate employment, investment, consumer purchasing ► Government needed to intervene in the free market to minimize business cycles ► these ideas have been applied by many governments to fight recessions in the economy. Aggregate Supply and Demand ► Aggregate Demand (AD) ►Total demand for all goods and services produced in a society ► Aggregate ►Total Supply (AS) supply of all goods and services produced in a society Let’s get Fiscal ► Fiscal Policy – government’s use of power to reach economic goals ► Power you say? ► Expenditures ► Taxation ► Borrowing ► Results in ► More consumer demand ► Increased employment ► Controlled inflation ► Discretionary ►Intentional Fiscal Policy action taken by the government to influence the economy and level the business cycle. Two Types of Discretionary Fiscal Policy ► 1) Expansionary Policy ► Implemented when country is in a recession and AD is too low, unemployment is high and there is no or negative growth (GDP) ► Through expansionary policy the government may ► Cut taxes ► Increase government spending in order to reduce unemployment ► These actions would increase consumer disposable income, leading AD, thereby creating more jobs and increasing economic output (GDP) ► 2) Contractionary Policy ► Occurs when inflation, AD, employment and economic growth is too high. ► Contractionary fiscal policy would result in ► Tax increases ► Less governement spending as a means to stop inflation. ► Taking these steps would result in less disposable income for consumers and would result in less AD, leading to less inflation, thereby leading to lower GDP ► These policies level out the peaks and valleys of the business cycle Government Budget ►3 Options Deficit budget – spending exceeds revenue from taxes Surplus budget – collects more tax revenue than what it spends Balanced budget – spending = tax revenue ► If the government is in a deficit it must borrow that money plus the interest. ► Example: Year 1 – Govt. Spending 200 billion Govt. Revenue 160 Billion Deficit = 40 billion Government must borrow $40 billion plus interest and eventually pay it back to the Bank of Canada (BOC) ► Deficit earned ► Debt – when more money is spent then – amount of money the government has borrowed to fund a deficit(s) Drawbacks of Fiscal Policy ► 1) There are significant time lags ► Recognition lag – the time it takes for the govt. to realize there’s a problem ► Decision lag – the time it takes to come up with a decision ► Implementation lag – the time it take act on their decision ► Impact lag – how long it takes for the full effects to be seen. ► In other words, IT TAKES TIME! Drawbacks of Fiscal Policy ► 2) May be challenging for the govt. to change spending and taxation policies already in place ►Unpopular to raise taxes ►Unpopular to cut spending ► 3) Conflict between different levels of govt. ►The federal govt. might be trying to slow down growth and the provincial government might be trying to increase economic growth. Drawbacks of Fiscal Policy ► 4) Regional Economic Variations across the country ►The west coast might need a concretionary policy while the east coast needs an expansionary policy ► 5) Large Debt = Limited use of fiscal policy ►If country has large debt and you want to implement an expansionary policy you don’t want to increase spending. ►Cutting taxes would be unpopular as well Drawbacks of Fiscal Policy ► 6) Deficits redistribute income from taxpayers to bondholders ►Govt. sell bonds to raise funds to pay off the debt ►Govt. pays interest on bonds with taxpayer money ►Corporations, foreign investors and the wealthy make up the majority of bondholders ►Redistributes of money from poor to wealthy ► 7) Deficits force a burden on future generations because debt removes capital from the country when interest is paid. ►If money is spent of roads, hospitals, education etc. then future generations will benefit ►If money is spent on employment insurance, salaries, etc. then future generations will not benefit HW ► Pg. 242 ►Questions 3 Answers to homework ► 3) When the economy is already at or above full-employment equilibrium, iti s already operating close to its maximum capacity. If an expansionary fiscal policy is implemented under these circumstances, it will lead to an increase in aggregate demand, which will put upward pressure on the price of inputs, and, therefore, the price of finished goods and services.