Transcript Fiscal Policy

Economics
NINTH EDITION
Chapter 10
Fiscal Policy
Prepared by Brock Williams
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Learning Objectives
10.1 Explain how fiscal policy works using aggregate
demand and aggregate supply.
10.2 Identify the main elements of spending and revenue for
the U.S. federal government.
10.3 Discuss the key episodes of active fiscal policy in the
U.S. since World War II.
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Fiscal Policy
• Fiscal policy
Changes in government taxes and spending that affect the level of GDP.
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10.1 THE ROLE OF FISCAL POLICY(1 of 5)
Fiscal Policy and
Aggregate Demand
Panel A shows that an increase in
government spending shifts the
aggregate demand curve from AD0
to AD1, restoring the economy to
full employment. This is an
example of expansionary policy.
Panel B shows that an increase in
taxes shifts the aggregate demand
curve to the left, from AD0 to AD1,
restoring the economy to full
employment. This is an example of
contractionary policy.
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10.1 THE ROLE OF FISCAL POLICY(2 of 5)
Fiscal Policy and Aggregate Demand
• Expansionary policies
Government policy actions that lead to increases in aggregate demand.
• Contractionary policies
Government policy actions that lead to decreases in aggregate demand.
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10.1 THE ROLE OF FISCAL POLICY(3 of 5)
The Fiscal Multiplier
• As the government develops policies to stabilize the economy, it needs to take the
multiplier into account.
• The total shift in aggregate demand will be larger than the initial shift. As we will see later
in this chapter,
• U.S. policymakers have taken the multiplier into account as they have developed
policies for the economy.
The Limits to Stabilization Policy
• Stabilization policies
Policy actions taken to move the economy closer to full employment or potential output.
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10.1 THE ROLE OF FISCAL POLICY(4 of 5)
The Limits to Stabilization Policy
LAGS
Panel A shows an example of successful
stabilization policy.
The solid line represents the behavior of GDP in
the absence of policies. The dashed line shows
the behavior of GDP when policies are in place.
Successfully timed policies help smooth out
economic fluctuations.
Panel B shows the consequences of ill-timed
policies.
Again, the solid line shows GDP in the absence of
policies and the dashed line shows GDP with
policies in place. Notice how ill-timed policies
make economic fluctuations greater.
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10.1 THE ROLE OF FISCAL POLICY(5 of 5)
The Limits to Stabilization Policy
LAGS
• Inside lags
The time it takes to formulate a policy.
• Outside lags
The time it takes for the policy to actually work.
FORECASTING UNCERTAINTIES
What makes the problem of lags even worse is that economists are not very accurate in
forecasting what will happen in the economy.
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APPLICATION 1
INCREASING LIFE EXPECTANCY AND AGING POPULATIONS
SPUR COSTS OF ENTITLEMENT PROGRAMS
•
APPLYING THE CONCEPTS #1: Why are the United States and many other countries
facing dramatically increasing costs for their government programs?
• Today, Social Security, Medicare, and Medicaid constitute approximately 10 percent of GDP.
• Experts estimate that in 2075 spending on these programs will be approximately 22 percent of
GDP.
How will our society cope with increased demands for these services?
Possible solutions:
• Leave the existing programs in place and just raise taxes to pay for them.
• The government should save and invest now to increase GDP in the future to reduce the burden
•
•
on future generations.
Reform the entitlement systems, placing more responsibility on individuals and families for their
retirement and well-being.
Reform the health-care system to encourage more competition to reduce health-care
expenditures.
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10.2 THE FEDERAL BUDGET (1 of 8)
Federal Spending
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10.2 THE FEDERAL BUDGET (2 of 8)
Federal Spending
• Discretionary spending
The spending programs that Congress authorizes on an annual basis.
• Entitlement and mandatory spending
Spending that Congress has authorized by prior law, primarily providing support for
individuals.
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10.2 THE FEDERAL BUDGET (3 of 8)
Federal Spending
• Social Security
A federal government program to provide retirement support and a host of other
benefits.
• Medicare
A federal government health program for the elderly.
• Medicaid
A federal and state government health program for the poor.
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10.2 THE FEDERAL BUDGET (4 of 8)
Federal Revenues
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10.2 THE FEDERAL BUDGET (5 of 8)
Federal Revenues
SUPPLY-SIDE ECONOMICS AND THE LAFFER CURVE
• Supply-side economics
A school of thought that emphasizes the role that taxes play in the supply of output in the
economy.
• Laffer curve
A relationship between the tax rates and tax revenues that illustrates that high tax rates
could lead to lower tax revenues if economic activity is severely discouraged.
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10.2 THE FEDERAL BUDGET (6 of 8)
The Federal Deficit and Fiscal Policy
• Budget deficit
The amount by which government spending exceeds revenues in a given year.
• Budget surplus
The amount by which government revenues exceed government expenditures in a given
year.
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10.2 THE FEDERAL BUDGET (7 of 8)
Automatic Stabilizers
The increased federal budget deficit works through three channels:
1. Increased transfer payments such as unemployment insurance, food stamps, and other welfare
payments increase the income of some households, partly offsetting the fall in household income.
2. Other households whose incomes are falling pay less in taxes, which partly offsets the decline in
their household income. Because incomes do not fall as much as they would have in the absence of
the deficit, consumption spending does not decline as much.
3. Because the corporation tax depends on corporate profits and profits fall in a recession, taxes on
businesses also fall. Lower corporate taxes help to prevent businesses from cutting spending as
much as they would otherwise during a recession.
• Automatic stabilizers
Taxes and transfer payments that stabilize GDP without requiring policymakers to take explicit
action.
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10.2 THE FEDERAL BUDGET (8 of 8)
Are Deficits Bad?
No – Automatic Stabilizers
Yes – Crowding Out
•
•
PRINCIPLE OF OPPORTUNITY COST
The opportunity cost of something is what you sacrifice to get it.
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APPLICATION 2
THE CONFUCIUS CURVE?
APPLYING THE CONCEPTS #2: How are tax rates and tax revenues related?
• While the idea that cutting tax rates might actually increase tax revenue is often
attributed to economist Arthur Laffer, in fact, it is actually a much older idea than that.
• Yu Juo, one of the twelve wise men who succeeded Confucius in ancient China, was
asked what should be done in the case of a famine if the government had insufficient
funds. He replied that the tax rate should be cut to 10 percent. Skeptical government
bureaucrats did not have enough funds at a 20 percent rate, so how could they cut it to
10 percent?
• Yu Juo replied, “Cutting taxes and limiting your expenses allow people to raise their
standard of living. Afterwards, you will no longer need to worry about famine and
shortage.”
• Revenue estimators in Washington, D.C, do not share entirely in Yu Juo’s wisdom, but
they do recognize that cutting tax rates will stimulate economic activity.
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10.3 FISCAL POLICY IN U.S. HISTORY (1 of 4)
The Depression Era
During the 1930s, politicians did not believe in modern fiscal policy, largely because they
feared the consequences of government budget deficits. According to Brown, fiscal policy
was expansionary only during two years of the Great Depression, 1931 and 1936.
The Kennedy Administration
Although modern fiscal policy was not deliberately used during the 1930s, the growth in
military spending at the onset of World War II in 1941 increased total demand in the
economy and helped pull the economy out of its long decade of poor performance. But to
see fiscal policy in action, we need to turn to the 1960s. It was not until the presidency of
John F. Kennedy during the early 1960s that modern fiscal policy came to be accepted.
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10.3 FISCAL POLICY IN U.S. HISTORY (2 of 4)
The Vietnam War Era
• Permanent income
An estimate of a household’s long-run average level of income.
The Reagan Administration
The tax cuts enacted during 1981 at the beginning of the first term of President Ronald
Reagan were significant. However, they were not proposed to increase aggregate demand.
Instead, the tax cuts were justified on the basis of improving economic incentives and
increasing the supply of output.
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10.3 FISCAL POLICY IN U.S. HISTORY (3 of 4)
The Clinton, George W. Bush, and Obama Administrations
• At the beginning of his administration, President Bill Clinton proposed a “stimulus
pachage” that would increase aggregate demand, but was defeated by Congress.
• Later, President Clinton, along with a Republican-controlled Congress, passed a major
tax increase to balance the budget and brought the Federal budget into surplus.
• In 2001, President George W. Bush passed a 10-year tax cut plan in part to stimulate
the economy.
• After September 11, 2001, President Bush and Congress authorized new spending to
stimulate the economy which had entered a recession.
• This was followed by other expansionary fiscal policy
• In 2009, President Obama and Congress enacted the largest stimulus package in U.S.
history.
• The stimulus was controversial in both size and composition.
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APPLICATION 3
HOW EFFECTIVE WAS THE 2009 STIMULUS?
APPLYING THE CONCEPTS #3: Was the fiscal stimulus in 2009 successful?
In 2009, President Obama signed into law the American Recovery and Reinvestment Act,
the largest fiscal stimulus in United States history. Although the recovery of the economy
from the 2007 recession was still sluggish, many economists—including those at the
Congressional Budget Office—believe that the stimulus did have a significant impact on the
economy.
But not all economists share this belief. James Feyrer and Bruce Sacerdote found that
additional spending on infrastructure and support for low-income households was
successful in generating economic activity, but spending on education was not.
John Taylor found little evidence that the temporary tax cuts stimulated consumption; they
were essentially saved. Taylor believes the stimulus was ineffective.
Others disagreed suggesting that without the aid to state and local governments, there
would have been more substantial cuts in spending on local services.
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10.3 FISCAL POLICY IN U.S. HISTORY (4 of 4)
In late 1990’s, tax
increases, limited
government spending,
and economic growth
which increased
revenues resulted in the
U.S. experienced a
surplus
Tax cuts and stimulus
packages designed to
stimulate the economy
after the recessions of
2001 and 2008 resulted
in U.S. deficits again.
Source: Congressional Budget Office, January 2015.
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KEY TERMS
Automatic stabilizers
Medicare
Budget deficit
Outside lags
Budget surplus
Permanent income
Contractionary policies
Social Security
Discretionary spending
Stabilization policies
Entitlement and mandatory spending
Supply-side economics
Expansionary policies
Fiscal policy
Inside lags
Laffer curve
Medicaid
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