chap011 fiscal policy

7/27/2019 Chap011 Fiscal Policy

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Fiscal PolicyChapter 11

Copyri ght 2010 by the McGraw-Hi ll Companies, Inc. All ri ghts reserved.McGraw-Hill/Irwin


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11-2

Fiscal Policy

Fiscal policy: The use of government taxes

and spending to alter macroeconomic

outcomes

The federal budget is a tool that can shift

aggregate demand and thereby alter

macroeconomic outcomes


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11-3

The Policy Goal

AS

QE

= 5.6

a

AD1

PE

Price

Le

vel

Real GDP

6.0 = QF

GDP Equilibrium

Full-employment GDP

b

GDP gap

The goal is to closeGDP gaps


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11-4

Keynesian Strategy

Fiscal stimulus: Tax cuts or spending hikes

intended to increase (shift) aggregate demand

Two strategic policy questions:

By how much do we want to shift the AD curve to

the right?

How can we induce the desired shift?


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11-5

The AD Shortfall

So long as the AS curve slopes upward, AD

must increase by more than the size of the

recessionary gap to achieve full employment

AD shortfall: The amount of additional

aggregate demand needed to achieve full

employment after allowing for price-level

changes


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11-6

Multiplier Effects

Impact of fiscal stimulus on aggregate demand

includes both the new government spending

and all subsequent increases in consumer

spending triggered by multiplier effects

Total change new spending multiplier

in spending injection


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11-7

Multiplier Effects

The second equation is identical to the first butexpressed in the terminology of fiscal policy

( ) AD( )

( )

new spendingCumulative increase induced increase

injectionhorizontal shift in in consumption

fiscal stimulus

fiscal stimulusmultiplier

new spending injection


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11-8

Multiplier Effects

Real GDP

Price

Le

vel

P1

5.6QE

5.8 6.4

AD2

AD3

Currentprice level

Direct impact of rise ingovernment spending

+ $200 billion

AD1

ab

Indirect impact viaincreased consumption

+ $600 billion


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11-9

The Desired Stimulus

The general formula for computing the desired

stimulus is a simple rearrangement of the

earlier formula:

AD shortfallDesired fiscal stimulus

the multiplier


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11-10

Tax Cuts

By lowering taxes, the government increases

disposable income, which stimulates the

consumption component of AD

The amount consumption increases depends on

the marginal propensity to consume

Initial increase MPC tax cutin consumption


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11-11

Multiplier Effects

A dollar of tax cut contains less stimulus thana same size increase in government purchases

desired fiscal stimulus

Desired tax cut MPC

Cumulative change initial changemultiplier

in spending in consumption


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11-12

Increased Transfers

Increasing transfer payments stimulates the

economy

( )Initial fiscal increase inMPC

stimulus injection transfer payments


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11-13

The Fiscal Target

AD excess: The amount by which aggregate

demand must be reduced to achieve full-

employment equilibrium after allowing for

price-level changes

The AD excess exceeds the inflationary GDP

gap


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11-14

The Fiscal Target

First determine the size of the AD excess

Then we compute how much government

spending or taxes must be changed to achieve

the desired shift, taking into account multiplier

effects

excess ADDesired fiscal restraintthe multiplier


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11-15

Budget Cuts

Budget cuts reduce government spending and

induce cutbacks in consumer spending

Budget cuts should equal the size of the

desired fiscal restraint

( )

Cumulative reduction initial budget cut multiplier

in spending fiscal restraint


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11-16

Tax Hikes

Tax hikes can be used to shift the AD curve to

the left by reducing disposable income

Taxes must be increased more than a dollar to

get a dollar of fiscal restraint

desired fiscal restraintDesired tax hike

MPC


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11-17

Weak Economy: Fiscal Stimulus

AD shortfallDesired fiscal stimulus

the multiplier

Policy Tools Amount

Increase governmentpurchases

desired fiscal stimulus

Cut taxes desired fiscal stimulus

MPC

Increased transfers desired fiscal stimulus

MPC


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11-18

Overheated Economy: Fiscal Restraint

excess ADDesired fiscal restraint

the multiplier

Policy Tools Amount

Reduce governmentpurchases

desired fiscal restraint

Increase taxesdesired fiscal restraint

MPC

Reduce transfers desired fiscal restraint

MPC


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11-19

A Warning: Crowding Out

Some of the intended fiscal stimulus may be

offset by the crowding out of private

expenditure

Crowding out: A reduction in private-sector

borrowing (and spending) caused by increased

government borrowing


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Fiscal PolicyEnd of Chapter 11

Copyri ght 2010 by the McGraw-Hi ll Companies, Inc. All ri ghts reserved.McGraw-Hill/Irwin

chap011 fiscal policy

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