discretionary 1. What is the difference between discretionary and nondiscretionary nondiscretionary fiscal policy? expansionary 2. What is the cause-effect

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<ul><li>Slide 1</li></ul> <p> Slide 2 Slide 3 discretionary 1. What is the difference between discretionary and nondiscretionary nondiscretionary fiscal policy? expansionary 2. What is the cause-effect chain for expansionary and contractionary contractionary fiscal policy? automatic stabilizers 3. What are the automatic stabilizers? Golden Age of Fiscal Policy 4. What period is considered the Golden Age of Fiscal Policy? crowding-out 5. What is the crowding-out effect? negative net export effect 6. What is the negative net export effect? lags 7. What are the lags involved in fiscal policy? Supply-side 8. What is Supply-side economists? Council of Economic Advisers 9. What is the Council of Economic Advisers and the Joint Economic Committee Joint Economic Committee? Slide 4 Discretionary Fiscal Policy [G &amp; T] can be used if further smoothing is required. Even if I have to dig a hole and cover it back up, I do have a job. John Maynard Keynes Father of Fiscal Policy Peak Peak Trough Trough Peak Peak Contraction Contraction Contraction Contraction Nondiscretionary Fiscal Policy can take Nondiscretionary Fiscal Policy can take 33 % to 50 % of the curves out of the business cycle. [ Automatic stabilizers, like welfare and unemploy. insur.] Expansion Expansion Slide 5 This chapter confronts the following questions: government spending and tax policies 1. Can government spending and tax policies help ensure full employment? 2. What policy actions will fight inflation help fight inflation? roles of government intervention 3. What are the roles of government intervention? Slide 6 1915Up until 1915, the federal government collected few taxes and spent little. 1902 350,000 peoplespent $650 million.In 1902, it employed fewer than 350,000 people and spent $650 million. 5 millionpeople $3 trillionToday, it employs nearly 5 million people and spends more than $3 trillion. Slide 7 Government Revenue 16th Amendment1913Government expansion started with the 16th Amendment to the U.S. Constitution (1913) which extended the taxing power to incomes. $2.6 trillionToday, the federal g overnment collects over $2.6 trillion a year in tax revenues. Slide 8 Real GDP Price Level AD 2 AD 1 SRAS $490 Y R $510 Y F PL 1 Recessions Decrease in AD LRAS Slide 9 Real GDP Price Level AD 2 AD 1 Full $20 Billion Increase in AD SRAS $490 Y R $510 Y F PL 1 Expansionary Fiscal Policy Expansionary Fiscal Policy [Increase G or decrease T w. M E of 4] LRAS $5 Billion in additional G spending Slide 10 Slide 11 Real Interest Rate, (percent) Quantity of Loanable Funds [*Use this graph if there is a chg in savings by consumers or chg in fiscal policy] [* Use the Money Market graph when there is a change in MS ] r=6%r=6%r=6%r=6% D1D1D1D1 F1F1F1F1 S balanced budget Starting from a balanced budget, if the G incr spendingdecr T G incr spending or decr T to get out of recession a recession, they would now be running deficitpushing a deficit and have to borrow, pushing up demand in the LFMincreasing up demand in the LFM and increasing the interest rate the interest rate. D2D2D2D2 r=8%r=8%r=8%r=8% F2F2F2F2 E1E1E1E1 E2E2E2E2 Borrowers Lenders $ 2 T G T Balanced Budget [G&amp;T=$2 Tr.] $2.2 T $2 T $2 T real interest rate Use the real interest rate with LFMlong-term LFM, because it is long-term. nominal interest rate Use nominal interest rate with money marketshort-term money market, as it is short-term. Slide 12 Real Interest Rate, (percent) Quantity of Loanable Funds r=6%r=6%r=6%r=6% D1D1D1D1 F1F1F1F1 S1S1S1S1 r=4%r=4%r=4%r=4% F2F2F2F2 E1E1E1E1 E2E2E2E2 Borrowers Lenders S2S2S2S2 The following would cause an increase in supply in the LFM and lower real interest rates: 1.Fed increases MS 2.HH save more 3.Business save more 4.Government saves more 5.Foreigners save more here [*Use this graph if there is a chg in savings by consumers or chg in fiscal policy] [* Use the Money Market graph when there is a change in MS ] Slide 13 Demand for Loanable Funds Market (a) (b) Demand for L oanable Funds at 3 % [no G borrowing] Business firms demand for L oanable Funds at 3 % [a lot of investment] Rate Interest 3% 3% S D 1[ no G] LFM A A Trillions of Dollars 3% 1.5 QID QID DIDIDIDI Low interest rates, so - a lot of investment Real Slide 14 Demand for Loanable Funds Market (a) (b) Rate Interest 3% 3% S D 1[ no G] LFM A Trillions of Dollars 3% 1.5 DIDIDIDI With G borrowing, the demand for LF goes to 5 % Business firms d emand for Loanable Funds at 5 % [not as much investment] D 2 (G) 5% QID1 QID1 Higher interest rates, so not as much investment 1.0 Government Demand for Funds Business Demand for Funds A B Real B 5%5%5%5% QID2 QID2 Slide 15 B alanced B udget [$2 T ril. G = $2 T ril. T] $2 Trillion G T Recession Incr G to $2.2 or or Decr T to $1.8 Deficit so higher I.R. Inflation Decr G to $1.8 or Incr T to $2.2 Surplus so Lower I.R. Budget So expansionary fiscal policy leads to higher interest rates. Deficit Wow! A surplus So, contractionary fiscal policy leads to lower interest rates. Gonna have to borrow Slide 16 Real GDP PL SRAS AD 2 YRYRYRYR YFYFYFYF [Incr G; Decr T] [ But we get negative Xn] P L1 AD 1 PL 2 G ADY/Empl./PL; G LFM I.R. T DIDIDIDICAD Y/Emp/PL; TLFM IRIRIRIR Start from a Balanced Budget G &amp; T = $2 Trillion $2 tr. I cant get a job. N ow, this is better. G T G T E1E1E1E1 E2E2E2E2 LRAS D1D1D1D1 D2D2D2D2S Loanable Funds Market r =6 % r =8 % Real In. Rate F1F1F1F1 F2F2F2F2 $2 tr. $2.2 tr. $2.2 $2.2 $1.8 $1.8 Slide 17 $2 T tril. Real GDP PL SRAS AD 2 YIYIYIYI YFYFYFYF [Decr G; Incr T ] [Again, we get negative Xn] P L1 AD 1 PL 2 G ADY/Empl./PL; G LFM I.R. T DIDIDIDICAD Y/Emp/PL; TLFM IRIRIRIR Start from a Balanced Budget G &amp; T = $2 Trillion $2 tril. G T G T [like we have money trees] E1E1E1E1 E2E2E2E2 LRAS Loanable Funds Market r =3 % r =6 % D1D1D1D1 D2D2D2D2 F1F1F1F1 F2F2F2F2 S $2.2 T tril. $1.8 tril.. $ 1.8 $2.2 $2.2 Real In. Rate Slide 18 Discretionary Fiscal Policy Deliberate use of government spending and/or taxing. G and T Nondiscretionary Fiscal Policy Automatic Stabilizers 1.Welfare &amp; food stamps 2. Unemploy. insurance 3. Social security 4. Corporate Dividends Progressive Tax System 5. Progressive Tax System Unempl. check Discretion of Congress Slide 19 recession : Suppose the economy is in recession : Real GDP Taxcollections Transfer payments GTG &gt; TGTG &gt; T The deficit grows [Automatic stabilizers ] AS AD 2 AD 1 Recession Y R Y R Y* PL Slide 20 inflationary gap If the economy has an inflationary gap : Taxcollections Transfer payments G</p>

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