Transcript Discretionary Fiscal Policy

The Role of Fiscal Policy
Carl E. Walsh
Professor, UC Santa Cruz
September 6, 2002
ECON 521
Special Topics in Economic Policy
Presented by:
Sareh Rotabi
Introduction
• US recession in 2002
• The recovery of the US economy from recent crash is on a
bumpy path
Indicators:
- In the 2nd Quarter of 2002, Real GDP growth on an annual rate barely grew over
1% (well below market expectations).
- Unemployment after rising in 2001 has stabilized but has yet to show signs of
declining.
- The stock market continued to drop through most of July and has remained volatile.
“This weak economic performance comes despite substantial stimulus from both
MONETARY & FISCAL POLICIES”
Introduction
Monetary policy: Since January 2001, Fed has reduces its interest rate
from 6.25% in September 2000 to a current level of 1.75%.
Expansionary fiscal policy: The federal government budget has shift from a
surplus of 236 bn dollars in 2000 to a projected 2002 deficit of 157 bn dollars as
Government expenditure increased and Tax rate declined.
The active use of fiscal policy during a recession is somewhat unusual!
In 1990 recession, G.W.Bush resisted attempts to use fiscal policy
to stimulate the economy. In contrast, during the current recession
both congress and the president have supported increase in G exp
and Tax reduction as a way to stimulate economic Growth.
The current recession & 1990-1991 recession offer contrasting example of the
use of fiscal policy. The author highlights some elements of the debate in
economics over whether fiscal policy can play a useful role in combating
business cycle downturns and issues involved in using Fiscal Policy to help
stabilize Short-Run fluctuation in the economy.
Automatic Stabilizers and Discretionary Fiscal Policy
• Automatic Stabilizers
- Fiscal expenditure & tax responds automatically as economic activity fluctuates.
Ex. Gov spending and Tax payment.
• Discretionary Fiscal Policy
- When government make discretionary fiscal changes in the face of an economic
downturn.
Expansionary Fiscal policy aim to boost demand and output in the economy either
directly (Through greater G exp) or indirectly (Through Tax reduction that
stimulate private consumption and investment spending).
The Problem of Lag
Argument against using discretionary fiscal policy to combat recession emphasizes
the long lag involved in changing fiscal policy in US.
Why Fiscal Policy use (Discretionary) in the States during Mild
Recession is AWKWARD?
By the TIME a fiscal program is starting to boost business and consumer
demand, that is:
1.
After policy makers recognize that economic growth has slowed
2.
Propose a fiscal package
3.
Debate it
4.
Pass it
5.
Send it to the president for his signature
The economy is likely to be RECOVERING!!!
The Roles of the Future Fiscal Policy
-Expectation of future fiscal actions, and not just the current G exp, Tax can
effect the economy.
- The DIFFRENCE between CURRENT CHANGES in Spending or Taxes
and EXPECTED FUTURE CHANGE is IMPORTANT because
HOUSEHOLDS and FIRMS consider FUTURE ECONOMIC
CONDITIONS, as well as CURRENT CONDITION in making their
SPENDING DECISION.
The IMPACT of a CHANGE in Fiscal Policy TODAY will depend on how
it affects individuals’ EXPECTATION about FUTURE Gov Spending and
Tax.
Example:
Temporary Tax cut on individuals Vs Investment Tax credit
Can Fiscal Expansion be Contractionary?
YES, When expectations of the future fiscal policy are
important, expansionary fiscal policy may actually be
contractionary!
Example: A government with a large budget deficit decides to
raise its expenditure
Consequences:
1.
2.
Financial markets may question the solvency of the government, or
Expect the tax will need to be raised in the future. This can cause the longterm interest rate to rise, restraining current investment spending and
canceling out the expansionary effect of the government spending.
Alesina, Perotti and Tavares (1998) found that deficit reduction are more
likely to be expansionary if they involve cut in Gov spending on
GOVERNMENT WAGES and TRANSFER. In contrast, deficit reduction
achieved through TAX INCREASE do seem to be contractionary.
Interaction with Monetary Policy
-Both fiscal and Monetary policy influence AD
-There are situation in which Monetary policy might be unable to stimulate
the economy. Ex. Great Dep, Japan in recent years
Conclusion
• The automatic Fiscal Stabilizer help moderate economic fluctuations
• The contribution discretionary fiscal policy can make in combating
economic recession is more debatable
• The long lag that typically characterize major changes in fiscal policy
WEAKEN the role discretionary policy can play during mild recession in
the US economy.
Automatic fiscal stabilizer and Discretionary Monetary
Policy remain the PRIMARY POLICY TOOLS for
MACRO-ECONOMIC STABILIZATION