Transcript Fiscal policy - McGraw Hill Higher Education

Chapter 6
Fiscal policy
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-1
Learning objectives
1. By what means can fiscal policy be used to eliminate
an output gap?
2. Why is there a difference between macroeconomic
effects of changes to government expenditure and
changes to taxes and transfer payments?
3. What are the three limitations on the ability of fiscal
policy to stabilise the economy?
4. How does fiscal policy impact on the distribution
of income?
5. What effect will demographic change have on
fiscal policy?
6. How is fiscal policy related to the level of public debt?
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-2
Chapter organisation
6.1
Government purchases and planned
spending
6.2
Taxes, transfers and aggregate spending
6.3
Fiscal policy as a stabilisation tool
6.4
Contemporary fiscal policy
Summary
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-3
Fiscal policy
• Two main components of fiscal policy are:
– government purchases
– taxes and transfer payments.
• Fiscal policy is designed and implemented by the
government to achieve a pre-determined level of
output in the economy.
• The Keynesian model is a simple analytical
framework that shows how changes in fiscal policy
can alter output in the economy.
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-4
Government purchases and planned
spending
• Intuition:
– As government purchases of goods and services is a
component of planned aggregate expenditure (PAE),
deficiencies in PAE can be compensated with changes in
government spending.
• Government expenditure is exogenous, therefore
changes in G will shift the PAE line.
– Contractionary gaps: An increase in G will shift PAE up and
increase the level of actual output.
– Expansionary gaps: A decrease in G will shift PAE down and
decrease the level of actual output.
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-5
Example: Government purchases and
contractionary gap
Figure 6.1 An increase in government purchases eliminates a contractionary gap
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-6
Example: Fiscal stimulus packages
and the GFC
Figure 6.5 The use of fiscal policy to fight the crisis
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-7
Chapter organisation
6.1
Government purchases and planned
spending
6.2
Taxes, transfers and aggregate spending
6.3
Fiscal policy as a stabilisation tool
6.4
Contemporary fiscal policy
Summary
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-8
Taxes, transfers and aggregate
spending
• Fiscal policy can also take the form of changes to the
level and types of taxes and transfer payments in the
economy.
– These payments are not for the purchases of current goods
and services, and are not part of G. Therefore, these
changes do not affect PAE directly.
• Taxes and transfer payments affect the level of
disposable income, (Y – T), received by the private
sector.
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-9
Taxes, transfers and aggregate
spending (cont.)
• Effects of changes to taxes and transfers on planned
aggregate expenditure:
– Tax cuts and increases in transfer payments increase
disposable income and raise planned aggregate
expenditure.
– Tax increases and decreases in transfer payments decrease
disposable income and reduce planned aggregate
expenditure.
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-10
Example: Tax cut and contractionary
gap
• Suppose the exogenous spending of 950 results in a
contractionary gap of 50 units.
PAE = Cd + IP + G + X
= C – T + IP + G + X + c(1 – t)Y
If c = 0.85 and the tax rate, t = 0.6, and we know the
coefficient in front of Y is 0.8:
PAE = Cd + IP + G + X + 0.8Y
= 950 + 0.8Y
Y = 4750 at equilibrium
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-11
Example: Tax cut and contractionary
gap (cont.)
Figure 6.6 A cut in the tax rate can eliminate a contractionary gap
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-12
Balanced budget multiplier
• Balanced budget multiplier is a situation in which an
exogenous increase in transfer payments by the
government was matched by a cut in government
spending, leaving the budgetary position unchanged.
• Will output remain unchanged in the case of a
balanced budget multiplier?
• The exogenous increase in payments to households
will be spent according to their marginal propensity to
consume, c.
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-13
Example: Baby bonus
Figure 6.7 The effect of the baby bonus on PAE
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-14
Chapter organisation
6.1
Government purchases and planned
spending
6.2
Taxes, transfers and aggregate spending
6.3
Fiscal policy as a stabilisation tool
6.4
Contemporary fiscal policy
Summary
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-15
Three qualifiers to using fiscal policy
as a stabilisation tool
• In reality there are complexities in the real world in
using fiscal policy to try to precisely change output,
including:
–
fiscal policy and the supply side
–
the problem of deficits
–
the fact that fiscal policy is relatively inflexible.
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-16
Fiscal policy and the supply side
• Fiscal policy affects potential output as well as
planned aggregate expenditure.
• Government spending, G, on public capital such as
roads, airports and schools play a major role in the
growth of potential GDP.
• Taxes and transfer payments play a role in affecting
incentives and therefore economic behaviour.
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-17
The problem of deficits
• Expansionary fiscal policy leads to deficits.
• It has been suggested that governments need to
avoid large and persistent deficits.
– Deficits reduce the level of national saving, which reduces
investment in new capital goods, an important source of
long-run economic growth.
• This makes increasing spending or cutting taxes a
less attractive option.
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-18
Fiscal policy is relatively inflexible
• Fiscal policy needs to act swiftly as output gaps arise.
– However, changing government spending or taxes is
subjected to political process.
– The government budget sets out planned government
spending and taxes each year. It is handed down in May and
can take months to take effect.
• Governments have agendas beyond stabilising
aggregate expenditure.
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-19
Fiscal policy as a stabilisation tool
• The qualifications for using fiscal policy to stabilise
the economy mean that aggregate spending is more
usually stabilised using monetary policy rather than
fiscal policy.
• However, fiscal policy still plays two important roles in
stabilising output:
1. Taxes and transfer payments act as automatic stabilisers to
the economy.
2. Fiscal policy is useful in dealing with prolonged recessions.
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-20
Automatic stabilisers
• Automatic stabilisers are legal provisions linking
changes in government spending and taxes to
output gaps:
– As GDP declines, the level of taxes paid falls and the level of
transfer payments made increase, because household
incomes decrease.
– As GDP increases, the level of taxes paid increases and the
level of transfer payments made decrease, because
household incomes increase.
• This happens automatically, without special
government action. This makes contractions and
expansions in GDP smaller than they would have
been otherwise.
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-21
Expansionary fiscal policy
• Fiscal policy is still useful in dealing with prolonged
recessions
• Examples in history:
– The Great Depression of the 1930s
– The Japanese recession of the 1990s
– The global financial crisis in 2008
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-22
Chapter organisation
6.1
Government purchases and planned
spending
6.2
Taxes, transfers and aggregate spending
6.3
Fiscal policy as a stabilisation tool
6.4
Contemporary fiscal policy
Summary
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-23
Contemporary fiscal policy
• Fiscal policy plays an important role in the economy,
even though stabilising the economy is not one
of them.
• Three key roles of fiscal policy in Australia today are:
1. affecting income distribution
2. responding to demographic change
3. managing public debt.
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-24
The distribution of income
• A key function of fiscal policy is to influence the
distribution of income between households in the
economy.
• This is done through influencing the total disposable
income available to households, which is done
through net taxes.
• Net taxes are the difference between tax paid by a
household and transfer payments received.
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-25
Progressive taxes and transfer
payments
• Australia has a system of progressive income taxes.
– The higher the income earned by the household, the
relatively higher proportion of tax is paid on that income.
– That is, the proportion of income paid as tax is higher at
higher income levels. The result is a less unequal distribution
of income.
• Government transfer payments are targeted toward
low income earners.
– These payments also narrow the gap that would otherwise
be much larger.
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-26
Example: Progressive taxes
TABLE 6.2 Income tax rates in Australia, 2009/2010
What is your income tax liability if your earn
$120 000? What if $60 000?
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-27
Relative income inequality
• We can get an indication of relative income inequality
through the use of Gini coefficients and Lorenz
curves.
– A Lorenz curve is a graphical representation of income
inequality.
– A Gini coefficient is a summary measure of income
inequality.
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-28
Example: Two hypothetical income
distributions
TABLE 6.3 Two hypothetical income distributions
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-29
Example: Two hypothetical income
distributions (cont.)
Figure 6.9
Lorenz curves
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-30
Gini coefficient
• The cumulative numbers for the two distributions are
then compared to a perfectly equal distribution:
– The bottom 20% of the population would earn 20% of the total
income; the bottom 40% of the population earning 40% of the
income, etc.
• This line is drawn on the graph, and the Gini coefficient
can be calculated as:
Gini =
area between the line of equality and the Lorenz curve
total area below the line of equality
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-31
Example: Two hypothetical income
distributions (cont.)
• In the earlier hypothetical income distributions
– For income distribution A: Gini = 0.274
– For income distribution B: Gini = 0.048
• In general, the lower the value, the closer the Lorenz
curve to the line of equality, and the more equal the
distribution.
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-32
Income inequality over time
TABLE 6.4
Selected Gini
coefficients
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-33
Managing demographic change
Figure 6.10 Projections of Australian government spending (real spending per
person, 2009–2010 dollars)
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-34
Tax revenue
• Tax revenue is difficult to forecast as it depends on a
number of different aspects such as level of
expenditure in the economy (will alter GST payable),
the level of business profits (business income tax),
the tax rate, as well as the number of taxpayers.
• Despite this, it is assumed that government revenue
as a proportion of GDP will stay the same at about
22%.
• Projection sees large deficits from about 2025
onwards.
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-35
Projected budget balances
Figure 6.11 Projected primary budget balances
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-36
Fiscal policy and the public debt
• Governments have three possible ways they can
finance their spending:
1. They can raise taxes, Tt.
2. They can borrow money.
3. They can simply print money to finance their spending.
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-37
Government budget constraint
• Government budget constraint
– Government spending comprises government expenditure in a
time period, Gt and transfer payments Qt.
– Let Bt – 1 be the stock of securities the government has owing at
the end of the previous period. Any new borrowing in the period t
means that Bt – Bt – 1 > 0. This also means there is a third
expenditure every period, which is the interest paid on its stock
of debt, rBt – 1, where r is the real rate of interest.
– Therefore, the spending that needs to be undertaken in the
period by the government which needs to be financed by some
method is:
Gt + Qt + rBt – 1 = Tt + (Bt – Bt – 1)
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-38
Increasing and decreasing public debt
•
We can rearrange this equation with gross taxes on
the left-hand side:
Gt + Qt – Tt + rBt – 1 = (Bt – Bt – 1)
– When the government runs a deficit budget, the left-hand
side is positive and we will be adding to the stock of
public debt.
– When the government runs a surplus budget, the left-hand
side is negative and the stock of debt will fall.
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-39
Benefits of low public debt
•
Low levels of public debt are desirable to reduce
crowding out, which is government borrowing
increasing interest rates and therefore decreasing
investment.
•
Borrowing because of deficit budgets can’t be
sustained forever, and eventually surpluses would
be required to reduce debt.
–
Intergenerational equity means we should not enjoy the
benefits of budget deficits now and pass on the costs of
those deficits to future generations.
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-40
Benefit of public debt
•
Public debt can also have a net benefit for the
economy, even when allowing for crowding out and
intergenerational equity effects.
•
This is when important infrastructure projects are
financed through public debt.
–
Such projects have been estimated to add 0.4% p.a. to
productivity for every 1% increase in public spending.
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-41
Chapter organisation
6.1
Government purchases and planned
spending
6.2
Taxes, transfers and aggregate spending
6.3
Fiscal policy as a stabilisation tool
6.4
Contemporary fiscal policy
Summary
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-42
Summary
• Fiscal policy involves the government deciding on the
level of spending, taxes and transfer payments.
• Fiscal policy is used to:
– stabilise output gaps in the short run
– redistribute income
– handle demographic change
– manage public debt
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-43
Summary (cont.)
• Expansionary fiscal policy
– Increasing government spending shifts the PAE function
– Decreasing tax rate pivots the PAE function
• Criticisms of fiscal policy
– Overly supply-side driven
– Mounting public debt
– Subjected to lengthy political process
Copyright  2011 McGraw-Hill Australia Pty Ltd
PowerPoint slides to accompany Principles of Macroeconomics 3e by Bernanke, Olekalns and Frank
6-44