Transcript Fiscal Policy

Chapter 7
Fiscal Policy
These slides supplement the
textbook, but should not
replace reading the textbook
1
Who were the
Classical Economists?
th
18
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A group of the
and
centuries, including Adam
Smith known as the father
of modern day economics
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What did Adam Smith
and the Classical
Economists believe?
The economy was always
tending toward a full
employment equilibrium
and stable prices
3
What does
laissez-faire mean?
Leave well enough alone,
let the economy correct
problems itself
4
What happened in the
Depression of 1921?
Even though it was
serious the
government practiced
laissez-faire and the
economy recovered in
a short period of time
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What were policies of
President Herbert Hoover
in the early 1930s to
combat the depression?




public works projects
raised taxes
loans to failing firms
relief programs
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What were policies of
President Franklin
Roosevelt in 1933 to
combat the depression?
 public works projects and
social welfare programs
 raised taxes and wages
 loans to failing firms
 relief programs
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According to Robert Reich,
an American political
economist and professor,
what was the result of these
government programs?
These programs helped
save American capitalism
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According to Thomas Woods
author of Meltdown, what
was the result of these
government programs?
These programs prevented the
economy from seeking its
equilibrium of full employment
and prolonged the depression
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What is a
fiscal policy?
The manipulation of
government purchases,
transfer payments,
taxes, and borrowing in
order to positively
influence the economy
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How did Keynes
influence fiscal policies?
He argued that fiscal
policies may be
necessary to bring
about full employment
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How did World War II
affect fiscal policies?
It showed that a
government stimulus
package can work
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What is the
Employment Act of 1946?
Its main purpose was to
lay the responsibility of
economic stability of
inflation and
unemployment onto the
federal government
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What are the four
phases of the
business cycle?
•
•
•
•
trough
recovery
peak
recession
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What are the 3 pillars
of
Keynesian Economics?
• Liquidity trap
• Balanced budget multiplier
• Paradox of thrift
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What is a
liquidity trap?
A lack of borrowing keeps
money bottled up in
savings institutions
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What is the
Keynesian solution to
a liquidity trap?
Government borrows the
money that consumers and
business do not borrow
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What is the
Balanced Budget
Multiplier?
When the government taxes
and spends the money
there is a multiple effect
because of no savings
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What is the
Paradox of Thrift?
The more people save, the
less will be demand, which
leads to slow growth
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What does crowding
out mean?
During periods of full
employment the
government can borrow
money that otherwise
would be spent or invested
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How does the
government borrow
money?
It sells bonds
(securities) to the Fed
or in the Open Market
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What is the current
national debt?
Just over $18.5 trillion
http://www.usdebtclock.org/
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What does monetizing
the debt (quantitative
easing) mean?
The federal government
sells bonds (securities)
to the Fed and the Fed
creates the money to
buy the bonds
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What can monetizing
the debt lead to?
A fall in the value of the
dollar and inflation
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What is a
discretionary fiscal
policy?
Government policies that
require ongoing decisions
by policy makers
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What are some examples
of fiscal policies?
Government purchases
Transfer payments
Taxes
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What are
automatic stabilizers?
Structural features of
government spending
and taxation smooth
out fluctuations in
booms and busts
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What are some
examples of
automatic stabilizers?
Unemployment payments
Welfare
Other govt. programs
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What is the point of
Keynesian Economics?
The economy could be
stuck at equilibrium below
the potential output for a
prolonged period of time
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What is an expansionary
fiscal policy?
An increase in government
purchases, decrease in net
taxes, or some combination of
the two aimed at increasing
aggregate demand
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When would the
government use
expansionary fiscal
policies?
To stimulate the economy
when unemployment is
greater than the natural rate
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What is a contractionary
fiscal policy?
A decrease in government
purchases, increase in net
taxes, or some combination
of the two aimed at reducing
aggregate demand
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When would the
government use
contractionary fiscal
policies?
To slow down the
economy when inflation is
more than desired
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What is the typical
Keynesian policy
during recessions?
To use discretionary fiscal
policies to stimulate the
economy to a full
employment equilibrium
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What is the multiplier?
Any change in the level
of spending has a
multiple effect on GDP
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What is the accelerator?
Any increase in spending
can lead to an increase
in secondary spending,
for example, a new
highway may lead to
more restaurants,
hotels, and gas stations
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When does the
accelerator have most
impact on spending?
During periods of
full employment
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How did World War II
affect fiscal policies?
It showed that a
government stimulus
package can work
38
What is MPC?
The marginal propensity
to consume (MPC) is a
measure of how much
consumers will spend
out of any addition to
their income
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What is MPS?
The marginal propensity to
save (MPS) is a measure
of how much consumers
will save out of any
addition to their income
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If MPC is ¾, what
is MPS?
MPS would be ¼ because
MPC + MPS = 1
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What is the value of
the multiplier?
1 / MPS
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If MPC is ¾, what is the
value of the multiplier?
1/¼=4
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$100.00
$75.00
$56.25
original spent
$42.19
$31.64 total money
...
$400.00
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What effect does an
increase in demand have
on prices and output?
The more steeply sloped
the supply curve the
greater impact on prices
and the less impact on
employment
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Slightly sloped Supply Curve
Price
Level
SRAS
AD*
AD
Real GDP
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Steeply sloped Supply Curve
Price
Level
SRAS
AD*
AD
Real GDP
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How effective are
fiscal policies?
Automatic stabilizers
are more effective
than are discretionary
fiscal policies
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Should we rely on
automatic stabilizers?
The stronger and more
effective the automatic
stabilizers are, the less
need there is for
discretionary fiscal policies
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How effective were fiscal
policies during the
stagflation of the 1970’s?
Whatever we did to fight
one problem we made
the other problem worse
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What are lag effects?
Recognition lag
Decision lag
Action lag
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Do lag effects
influence discretionary
fiscal policies?
Yes, they weaken fiscal
policies as a tool of
economic stabilization
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What is one’s
permanent income?
Income that individuals
expect to receive on
average over the long term
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Do consumers base their
decisions on their
permanent income or their
short term income?
Perceived long term income
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What is one thing policy
makers often overlook?
How fiscal policies
unintentionally affect
individual incentive to
work, save and invest
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What is the
Laffer Curve?
A curve that shows that
starting from zero an
increase in taxes will
raise revenue but beyond
a point an increase will
lower revenues
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What is the Laffer Curve?
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What is
supply side economics?
The belief that real GDP
can be increased by
giving people
incentives to work
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What was fiscal policy in
the Reagan Administration
of the 1980’s?
Taxes were decreased
to stimulate the
economy by increasing
aggregate supply
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What effect does politics
have on fiscal policies?
There is always the
danger that politicians
can use discretionary
fiscal policies to suit their
short term political goals
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Does the federal deficit
affect fiscal policies?
If we were to increase
spending by borrowing,
the national debt could
become unmanageable
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Watch video on the
National Debt
http://video.search.yahoo.com/video/pl
ay?p=national+debt&n=21&ei=utf8&js=1&fr2=tabweb&tnr=20&vid=000165545891
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What is the difference
between a stock and a
flow way of thinking?
An example of a stock
situation would be an
increase in government
spending has no
opportunity costs
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If we spend a dollar
do we pay for that
dollar here and now?
Yes, either by higher
taxes, higher interest
rates if we borrow the
money, or more inflation
if we create the money
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END
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