Transcript acrroecon-policies-g12-2

(2) Macroeconomic Policies
• What are the economic objectives for a
government?
• High and growing real GDP and GDP per capita
– Low unemployment rate
– Low and stable inflation rate
• (Equitable distribution of income)
• (plus : favourable exchange rate and balance of payments))
GDP Around the World
• There are 243 countries as of 2013, top 43 countries owns over
90% of the GDP in 2013
Unemployment Rate Around the World
Inflation Around the World
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The highest inflation rates today are seen in the developing world and in crisis
countries e.g. South Sudan highest with 79%, Syria 37%, Iran 32%
Zimbabwe in crisis, in 2008 reached 79,600,000,000% monthly inflation rate
Former USSR countries transiting to Market Based Economy: Hungary, Poland,
Czech Republic, Ukraine, Eastern Germany, etc. also reached record high rates!
Government Reactions
• MAIN CHOICE:
• INTERVENTION
• Vs
• LAISSEZ-FAIRE
Ultimate Questions:
– Can we consistently manage growth so
that there is also low and stable inflation
and low unemployment?
– Moreover, is equitable growth possible?
Growth for all? If not, where do we strike
a balance between growth and equity?
Gini Index and Income Inequality
Can High GDP and Income Equality Co-exist?
Equitable Economic Growth possible ?
Demand-Side (Keynesian) Policies
• Demand side policies (demand management)
focus on changing the AD to achieve potential
economic growth, full employment (NRU), and
price stability
• Stabilization or counter-cyclical
Expansionary (EASY or LOOSE) vs
Contractionary (AUSTERE or TIGHT)
When would each type be used?
Available Policies
– 1. Demand Side Policies
– 2. Supply Side Policies
Within Demand-Side Policies:
FISCAL
Expansionary
(Loose)
Contractionary
(Tight)
MONETARY
2 Main Scenarios for Intervention
• Two Gaps of Macroeconomic Economy
– Recessionary (deflationary) gap
– Inflationary gap
• The key to identifying these gaps were where the
current equilibrium level of output (𝒀𝒆 ) is in
comparison to the potential level of output (𝒀𝒑 )
• Two Responses of Demand Side Policies
– Expansionary Fiscal Policy and Monetary Policy
– Contractionary Fiscal Policy and Monetary Policy
Demand Side Policies
• Demand side policies (demand management)
are policies focused on changing
• AD = C + I + G + NX
• Two major types and classifications:
–Discretionary policy
• Fiscal Policy
• Monetary Policy
–Non-discretionary policy
• Automatic stabilizers e.g. progressive income tax and
UE benefits
Automatic Stabilizers
• Automatic stabilizers are policies that automatically, without any
action by the government, tend to stabilize the economy by
reducing the fluctuations of the business cycle
• Two main types of AUTOMATIC Stabilizers in Fiscal policy:
– Progressive income tax
• Income tax (wages, interest, dividend) where as the income increases, the
proportion of income paid as taxes increases; there is an increasing
marginal tax rate
• For an increase in real GDP, the tax revenue increases, causing
DISPOSABLE income to be lower than it would otherwise be exerting a
downward pressure on AD (less inflationary pressure) (and vice versa).
(Other taxes such as corporate tax, consumption tax, or special taxes on luxury
goods will also tend to rise)
– Unemployment benefits /pay/ welfare benefits
• Social insurance provided by the government to provide benefits for those
who have been unemployed e.g. to maintain families’ ability to live,
reduce the negative externalities of poverty, provide training, etc.
• For a decrease in real GDP, as workers become unemployed, their
consumption will be maintained to some extent as the benefits partially
replac their lost income, thus lessoning the downward pressure on AD
Fiscal Policy
(Group VI Tues)
• Fiscal policy refers to manipulations by the
government of its own expenditures (G) and
revenues (T) to influence the level of AD
– For the Japanese government’s budget, what were some
of the components of their spending? And types of taxes?
• But fiscal policy also affects the other 3 AD
components
– Consumption (C): consumption and income tax
– Investment (I): business and corporate tax
– Net Exports (NX): tariffs and quotas
DISCRETIONARY STABILISERS
using the BUDGET
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EXPANSIONARY:
………………….. G and/or ………………….. T
CONTRACTIONARY:
………………….. G and/or ………………….. T
• For both PLUS………MULTIPLIER effects.
• (Also consider the TAXATION Multiplier and
the BALANCED BUDGET Multiplier)
Discretionary policy to fill a deflationary
OR inflationary gap
(Group VI)
• 1) Government must estimate the gap between the
equilibrium output and “full employment” output
(potential output).
• 2) It must estimate the value of the multiplier so it can
judge the suitable increase/decrease in AD that is
necessary to inject into the economy in order to fill the
gap.
• But consider analogy of driving (steering) a car with no
front windows (cannot forecast) or side windows, and
the brake and accelerator are unpredictable and
LAGGED . Could it crash or overheat?
Taxation Multiplier
•
(formula is optional)
•=
𝑚𝑝𝑐
1−𝑚𝑝𝑐
• Implication:
• Impact of a change in taxation
is……………….than impact of a change in govt.
expenditure
 Balanced Budget Multiplier
• If government raise G by $1000 and, at the
same time, raise T by $1000….
• What is the effect on…
• 1) The budget?...............................
• 2) National Income
(output/expenditure)?…………………………
•  size of Balanced Budget Multiplier=…………?
Output Gap (Actual – Potential Output)
Gov Expenditure and Revenue Together:
•
Japan
Consider whether the BUDGET is in SURPLUS, DEFICIT or BALANCED
United States
?
Fiscal and Monetary Policy
• In face of deflationary/recessionary gap, what
would you do?
– Fiscal policy:………… BUDGET moves towards
a……………..
– (Monetary policy:…………………………………)
Review: Fiscal and Monetary Policy
• In face of inflationary gap,what would you do?
– Fiscal policy:………… BUDGET moves towards
a……………..
– (Monetary policy:…………………………………)
Summary of Fiscal Policy
• Fiscal policy refers to the government changing its expenditures (G) and
revenues (T) to influence the level of AD
• But fiscal policy also affects the other 3 AD components
– Consumption (C): consumption and income tax
– Investment (I): business (corporate or company) taxes
– Net Exports (NX): tariffs and quotas
Need to calculate the multiplier to determine the correct amount of
change in G or T
Also distinction between: Discretionary policy and
– Non-discretionary policy (Automatic stabilizers e.g. progressive
income tax and unemployment benefits)
•  Consider whether the BUDGET is ……..
in SURPLUS,
• in DEFICIT or
• BALANCED
•  Review page 6 on H/0 (New Classical vs Keynesian) + Formative
WS (2) + Paradox of Thrift (Page 10)
Keynesian Demand-Side policy - EVALUATION
Group III (after finishing Page 6)
PROS
CONS
Can ”fine-tune” the economy so that it can
grow at close to its potential rate without
booms and slumps. Counter-cyclical and
stabilisation
Risk of inflation unless there is spare
capacity (an almost horizontal AS curve)
Can reduce Keynesian/demanddeficient/cyclical* unemployment
(*unemp. > NRU)
Expansionary policies  need to have a
budget deficit need to borrow (see next
slide)
Keynesian Demand-Side policy - EVALUATION
PROS
CONS
Can “fine-tune” the economy so
Risk of inflation unless there is
that it can grow at close to its
spare capacity (an almost
potential rate without booms and
horizontal AS curve)
slumps (counter-cyclical/stabiliszing)
Can reduce Keynesian/demanddeficient/cyclical* unemployment
(*unemp. > NRU)
Expansionary policies  need to
have a budget deficit  need to
borrow (by issuing bonds)
national debt rises  costs of
financing (servicing) debt
As real GDP rises, tax revenues rise
and G expenditure on unemp. pay
falls deficit will eventually narrow
(Page 10 of H/)0
 Risk of crowding out of
firms’ investment (if
interest rate rises).
But will not rise if increase in
Money supply (quantitative
PROS (con)
Cons
Automatic stabilizers
 Risk of crowding out of firms’
investment (if interest rate
rises).
But will not rise if increase in
Money supply (quantitative
easing)
OR if excess savings
IF extra investment generated as AD
and GDP increase-----SUSTAINED
GROWTH AS LRAS MOVES RIGHT
GDP stats unreliable and forecasts
change. Parameters (eg mpc)
change
Can be used to DECREASE inflation
Lags
(CONTRACTIONARY or TIGHT Policies)
-- possibly cycles are amplified
Crowding Out Effect
Is “crowding out” happening in Japan?
Corporate Tax Rates
Consumption Tax Rates
Personal Income Tax
(varies by level of income)
To sum, Is it such an easy task? Not quite so …
• One intervention has multiple mechanisms in affecting the
various demand components.
• Ceteris paribus is critical! But in the dynamic reality, hard
to make such assumption and therefore hard to predict and
forecast and it can get out of control!
• The multiplier effect
– The national income will/should increase by more than how
much the government will spend as the increase in spending
circulates the economy
• The two schools of thought
– Quite different on the implications on price and real GDP level
(monetarist believe no effects on real GDP, only on avg prices)
• We considered only the Demand Side, also need to
consider the Supply Side Policies
•  Macroeconomic Management is difficult!
•  formative WS 2 (pp 11-12 of H/0) and to Monetary Policy
Is it such an easy task ? (continued)
• Fiscal Policy
– Pro: can pull economy out of recession (e.g. Great Dep ‘30);
deal with escalating inflation; ability to target sectors (e.g.
spending on education, infrastructure) with some supply side
effects
– Con: time lags; hard to forecast their impacts and the causal
mechanisms; political constraints with so many factors and
components of G and T; crowding out effect (as G increase,
need to borrow, interest rate increases lessening C and I); tax
cuts increase savings rather than C; hard to target and fine tune
as AD determined by multiple factors
Government Expenditure (G)