Transcript Fiscal Policy

Fiscal Policy
When the government deliberately
changes its taxation or spending
policies in order to influence the
level of activity in the national
economy.
Fiscal Policy History

John Maynard Keynes
– “General Theory” published 1936
– Keynesian Policy (Theory)

FDR – New Deal
– 1933 Fix problems of Great Depression

Full Employment Act of 1946
– Post World War II
– Fear of a return to the Great Depression
– Congress set goals for management of national
economy
Fiscal Policy – Basic Theory

Capitalism (Market Economies)
– are not stable.
– Economy can get stuck in recession/depression
– Consumer expectations “animal spirits” are
important

Government needs to be significant part of
economy. (GDP = C + Ig + G)
– Current GDP $15.2 trillion
– Federal Budget $3.7 trillion
Fiscal Policy – Basic Theory

Multiplier Effect magnifies government actions.
Who
Gov’t Inject
Amy
Bob
Cathy
Dennis
Elaine
Frank
Gigi
Hank
Irene
Joe
Total
Spend
$1000
$ 900
$ 800
$ 700
$ 600
$ 500
$ 400
$ 300
$ 200
$ 100
$
0
$5,500
Taxes
$100
$100
$100
$100
$100
$100
$100
$100
$100
$100
$1,000
Real World multiplier is roughly 2.
Fiscal Policy Actions

Performed by Congress & President
– Federal Budget Process

During Contractions (Unemployment)
– Increase government spending
– Decrease taxes
– Deficit spending is OK
Fiscal Policy Actions

During Expansions (Inflation)
– Decrease government spending
– Increase taxes
– Surplus budget
– Long run balanced budget
Fiscal Policy Limitations

Cyclical Asymmetry


Time Lags




Congress
– Easy to cut taxes and/or increase spending
– Hard to raise taxes and/or decrease spending
Recognition
Policy discussion
Implementation
Monetary Policy

2nd method to control the economy
Fiscal Policy

Automatic Fiscal Policy
– Solves problems of time lags
– During contractions
 Unemployment Insurance
 Welfare Programs
 Progressive Income Tax
Tax Rate
Married Couples Filing Jointly
Most Single Filers
10%
Not over $16,750
Not over $8,375
15%
$16,750 --- $68,000
$8,375 --- $34,000
25%
$68,000 --- $137,300
$34,000 --- $82,400
28%
$137,300 --- $209,250
$82,400 --- $171,850
33%
$209,250 --- $373,650
$171,850 --- $373,650
35%
Over $373,650
Over $373,650
Fiscal Policy

Discretionary Fiscal Policy
– Used when automatic stabilizers are not enough.
 G.W. Bush’s Tax Rebate checks (2x)
 Bailouts of Financial & Auto Industry
 Obama’s stimulus package
 Obama & Republican’s compromise on taxes.
Price Level (Inflation)
AD – AS Model Aggregate Demand -- Aggregate Supply
AS
Potential GDP
Output (GDP)
Price Level (Inflation)
AD – AS Model
AS
AD
Current GDP is less than
Potential GDP
Economy is in Recession
Fiscal Policy should
attempt to increase GDP
by increasing AD
Potential GDP
Output (GDP)
Current GDP
AD – AS Model
Current GDP is maximized
Inflation is increasing
Price Level (Inflation)
AD
AS
Fiscal policy should attempt
to reduce inflation by
decreasing AD
Accelerating Inflation
Potential GDP
Output (GDP)
Aggregate
Demand
1
2
3
4
Taxes
Government
Spending
Federal
Budget
National
Debt
Aggregate
Demand
1
2
3
4
Taxes
Government
Spending
Federal
Budget
Toward
Deficit
National
Debt
Aggregate
Demand
Taxes
Government
Spending
Federal
Budget
1
Toward
Deficit
2
Toward
Surplus
3
4
National
Debt
Aggregate
Demand
Taxes
Government
Spending
Federal
Budget
1
Toward
Deficit
2
Toward
Surplus
3
Toward
Deficit
4
National
Debt
Aggregate
Demand
Taxes
Government
Spending
Federal
Budget
1
Toward
Deficit
2
Toward
Surplus
3
Toward
Deficit
4
Toward
Surplus
National
Debt
Aggregate
Demand
Taxes
Government
Spending
Federal
Budget
1
Toward
Deficit
2
Toward
Surplus
3
Toward
Deficit
4
Toward
Surplus
National
Debt
5 Stagflation: Traditional Keynesian Policy can’t fix this!
Discretionary or Automatic?
Expansionary or Contractionary ?

Recession raises amount of unemployment
compensation.
– Automatic

- Expansionary
The Government cuts personal income-tax rates.
– Discretionary - Expansionary

The government eliminates favorable tax
treatment on long-term capital gains.
– Discretionary - Contractionary
Discretionary or Automatic?
Expansionary or Contractionary ?

Incomes rise; as a result, people pay a larger
fraction of their income in taxes.
– Automatic

- Contractionary
As a result of a recession, more families qualify
for food stamps and welfare benefits
– Automatic - Expansionary

The government eliminates the deductibility of
interest expense for tax purposes
– Discretionary - Contractionary
Discretionary or Automatic?
Expansionary or Contractionary ?

The government launches a major new space
program to explore Mars.
– Discretionary

- Expansionary
The government raises Social Security taxes.
– Discretionary - Contractionary

Corporate profits increase; as a result, government
collects more corporate income taxes
– Automatic - Contractionary
Discretionary or Automatic?
Expansionary or Contractionary ?

The government raises corporate income tax rates.
– Discretionary

- Contractionary
The government gives all its employees a large
pay raise.
– Discretionary - Expansionary

President Obama proposes to continue the FICA
(Social Security) tax cut into 2012.
– Discretionary - Expansionary

Keynes Rap
 PBS debate / rap on Keynes
 Keynes vs. Hayek: Late Economists' HipHop Legacy | PBS NewsHour | Dec. 16,
2009 | PBS
 Round 2

Economist Magazine online dictionary
Animal spirits
http://www.economist.com/research/economics/alphabetic.cfm?letter=A

The colourful name that Keynes gave to one of the
essential ingredients of economic prosperity: confidence.
According to Keynes, animal spirits are a particular sort
of confidence, "naive optimism". He meant this in the
sense that, for entrepreneurs in particular, "the thought of
ultimate loss which often overtakes pioneers, as
experience undoubtedly tells us and them, is put aside as
a healthy man puts aside the expectation of death".
Where these animal spirits come from is something of a
mystery. Certainly, attempts by politicians and others to
talk up confidence by making optimistic noises about
economic prospects have rarely done much good
Liquidity trap


When MONETARY POLICY becomes impotent. Cutting the rate
of INTEREST is supposed to be the escape route from economic
RECESSION: boosting the MONEY SUPPLY, increasing
DEMAND and thus reducing UNEMPLOYMENT. But
KEYNES argued that sometimes cutting the rate of interest, even
to zero, would not help. People, BANKS and FIRMS could
become so RISK AVERSE that they preferred the LIQUIDITY of
cash to offering CREDIT or using the credit that is on offer. In
such circumstances, the economy would be trapped in recession,
despite the best efforts of monetary policymakers.
KEYNESIANs reckon that in the 1930s the economies of both
the United States and the UK were caught in a liquidity trap. In
the late 1990s, the Japanese economy suffered a similar fate. But
MONETARISM has no place for liquidity traps. Monetarists pin
the blame for the Great DEPRESSION and Japan’s more recent
troubles on other factors and reckon that ways could have been
found to make monetary policy work.