Transcript Review, Chapters 15-17

Fiscal policy Changes in federal taxes and purchases that are
intended to achieve macroeconomic policy objectives
Fiscal Policy: Congress & President (Treasury/OMB)
Monetary Policy—ain’t fiscal policy—The Fed does M-policy
Fiscal automatic stabilizers Government spending and taxes
that automatically increase or decrease with the business cycle
•progressive income tax/unemployment benefits/food stamps /
other entitlements
Cyclically
adjusted budget deficit or surplus The deficit or
.
surplus in the federal government’s budget if the economy were at
potential GDP.
Tax wedge The difference between the pre-tax and post-tax
return to an economic activity.
Disincentive to work???  Supply-side tax cuts
Government Purchase and Tax Multipliers
The Multiplier Effect
and Aggregate Demand
Government Purchase Multiplier
The Multiplier Effect
of an Increase in
Government Purchases
This spending multiplier is
analogous but not the same
as the deposit multiplier
The Government Tax Multiplier
Cut in tax rates affects equilibrium real GDP in two ways:
(1) disposable income rises  consumption spending rises
(2) the rate at which purchasing power leaks from the spending
stream declines  the spending multiplier increases
The less the marginal propensity to leak, the greater the
spending multiplier.
Recall:
Spending Multiplier = 1/[Marginal Propensity to Leak]
= 1/[Propensity Not to Respend Additional Income Domestically]
=1/[Propensity to pay taxes, save and buy things from abroad]
The Government Purchases and Tax Multipliers
Taking into Account the Effects of Aggregate Supply:
Slowing the Multiplier
Because the Price Level rises,
Real GDP does not increase as much
as it otherwise would
 The multiplier effect is reduced
Crowding out A decline in private expenditures as a result of
an increase in government purchases…slowing the multiplier
Money market
An Expansionary Fiscal Policy
Increases Interest Rates
The Limits of Using Fiscal Policy
to Stabilize the Economy
Crowding Out in the Short Run
The Phillips Curve
The 1960s: A Policy Menu?
Phillips curve A curve showing the shortrun relationship between the unemployment
rate and the inflation rate.
Explaining the Phillips Curve with Aggregate Demand
and Aggregate Supply Curves
As long as SRAS is stable, get Phillips Curve relation
Phillips curve A curve showing the shortrun relationship between the unemployment
rate and the inflation rate.
Explaining the Phillips Curve with Aggregate Demand
and Aggregate Supply Curves
As long as SRAS is stable, get Phillips Curve relation
Phillips curve shifts…
If people expect high inflation…
The Short-Run and Long-Run Phillips Curves
The Inflation Rate and the
Natural Rate of Unemployment
in the Long Run
Nonaccelerating
inflation rate of
unemployment (NAIRU)
The unemployment rate
at which the inflation rate
has no tendency to
increase or decrease.
Equilibrium unemploy
“Natural” unemploymt
The Balance of
Payments of the
United States,
2006 (billions of
dollars)
Don’t forget net
compensation of
nationals working
abroad
(= Labor Services)
The Balance of Payments
balances:
Current Account
+
Financial Account
+
Capital Account
CURRENT ACCOUNT
Exports of goods
$1,023
Imports of goods
−1,861
−838
Balance of trade
Exports of services
423
Imports of services
−343
Balance of services
Income received on investments
Income payments on investments
80
650
−614
Net income on investments
−36
Net transfers
−90
−812
Balance on current account
FINANCIAL ACCOUNT
Increase in foreign holdings of assets in the
United States
1,860
Increase in U.S. holdings of assets in foreign
countries
−1,055
+
Balance on Financial Account
Statistical Discrepancy BALANCE ON CAPITAL ACCOUNT
=
Statistical discrepancy
ZERO
Balance of payments
805
-4
11
0
The Effect of a Government Budget Deficit
on Current Account Balance
The Twin Deficits, 1978–2006
Current Account Deficit = Net Capital Inflows = National Borrowing = (I – Sprivate) + (G – T)
= - NFI = Private Borrowing + Public Borrowing
The Foreign Exchange Market and Exchange Rates:
The Operation of Supply and Demand for a Currency
Equilibrium in the Market for Foreign Exchange
Foreign demand for US dollar:
•Buy US stuff
•Currently produced goods
and services
•Buy US assets
•Stocks
•Bonds
•Real estate
•Hotels and factories (fdi)
•Hold $ in US banks
•Transactions demand
•Speculative demand