Transcript Chapter 16
Chapter 16 Macroeconomic Policies © 2003 South-Western College Publishing 1 Macroeconomic Policies Expansionary Policies Monetary and fiscal policies that are used to try to increase the equilibrium level of income and output in the economy Contractionary Policies Monetary and fiscal policies that are used to try to lower aggregate demand for output in the economy to a level that can be achieved with full employment of all resources 2 Expansionary Policies Automatic Stabilizers Forces within the economy that naturally tend to counteract recessions and inflation; ex., the Social Security system, unemployment compensation, progressive income tax Fiscal drag Slowing effect on the economy resulting from a budget surplus Fiscal stimulus Activating effect on on the economy resulting from a budget deficit 3 Expansionary Policies Monetary policy Increase in the money supply lower interest rates increases the level of aggregate expenditures during periods of high unemployment Discretionary fiscal policy Tax financing Debt financing Financing by creating money 4 Tax Financing When taxation used to finance increased government spending, caution must be used so as not to tax funds that would otherwise be used for consumption & investment Object here should be to design a tax to absorb idle funds 5 Debt Financing If purpose is to increase aggregate spending, borrowing is more desirable method of raising funds for government spending Source of the borrowing has a direct bearing on the effectiveness of this approach Crowding out Occurs when deficit spending by the government drives interest rates up and leads to declines in private investment spending 6 Debt Financing Ricardian Equivalence Theorem Proposition that if makes no difference whether government spending is financed by taxes or a deficit In either case, the transfer of resources from the private sector to the government leads to having no net effect on the aggregate economy Based on rational expectations, individuals realize that deficits must be paid off in the future taxes will rise to pay off the debt they will reduce spending just as they would if taxes were increased 7 Financing by Creating Money Treasury sells bonds to the Fed (or to the public) to finance government spending When Treasury (or public) spends this money to make purchases, the result is an increase in the money supply This process is referred to as either Printing money because it increases the money supply Monetizing the debt 8 Methods of Increasing Government Spending Increase government spending and hold taxes constant Hold government spending constant and decrease taxes (tax rebate plan) Increase government spending and increase taxes proportionally Balanced budget multiplier 9 Discretionary Government Spending Discretionary government spending Transfer payments Public works Problems with discretionary spending Difficult to end a government spending program Problems balancing when the program is needed and when it can begin 10 Expanding the Economy The Great Depression The New Deal Expansionary Policies of the 1960s Expansionary Policies of the 1970s, 1980s & 1990s Recession of 1974-75 Recessions of 1980 and 1982 Recession of 1990-91 2001 Recession 11 Recession and Deflation Deflation persistent decrease in the level of prices Disinflation a slowdown in the rate of inflation 12 Inflation & Types of Inflation Inflation Persistent increase in the level of prices Demand-Pull Inflation Occurs when the total demand for goods and services exceeds the available supply of goods and services in the short run Cost-Push Inflation Characterized by a spiral of wage and benefit cost increases and price increases Stagflation Inflation and high unemployment occurring at the same time 13 Measures to Reduce Total Spending Automatic Stabilizers Monetary Policy Use of measures to reduce the money supply Other Measures Credit restraints, limits on borrowing for stock purchases Government Surplus Hold taxes and decrease spending Increase taxes and hold or decrease spending Decrease taxes and decrease spending Borrowing 14 Wartime Inflation Wartime economy entails a significant reallocation of resources Need for Reducing Consumption and Investment Taxation Voluntary Savings Compulsory Savings Other Measures 15 Trade-Off Between Unemployment and Inflation Phillips curve Curve showing the relationship between unemployment and inflation More accurately describes the short-run rather than the long-run relationship Natural rate of unemployment 16 Hyperinflation in Latin America Hyperinflation Inflation that feeds on itself to go out of control, creating severe distortions in an economy and rendering its currency almost worthless Central and South America Bolivia experienced a 11,750% inflation rate in 1985 Argentina has experienced inflation rates as high as 3,030% in 1989 Inflation rates in Venezuela have ranged from 31% in 1992 to 61% in 1994 17 Contracting the Economy – 1960s Use of voluntary wage and price guideposts suggested by President Kennedy President Johnson imposed a temporary 10% surcharge on personal and corporate income taxes Surtax fell more heavily on savings than consumption with result that little success was achieved in arresting inflation 18 Contracting the Economy – 1970s President Nixon declared a 90-day freeze on all prices, wages, and rents Imposed surtax on imports Asked Congress to reduce personal taxes and repeal some excise taxes Wage and price freeze offered only temporary success Stagflation President Carter once again announced a set of voluntary wage and price controls that were largely unsuccessful 19 Contracting the Economy – 1980s Reagan shifted from a demand-side approach to dealing with the dual problems of unemployment and inflation to a number of supply side measures Measures Encourage saving Stimulate investment Motivate work effort Generally successful 20 Contracting the Economy – 1990s Kuwaiti oil Crisis and Gulf War Increased taxes without reducing government spending Increased money supply President Clinton Contractionary fiscal policy Expansionary monetary policy Presided over longest peacetime expansion in U.S. 21