MEASURING FISCAL STIMULUSEC4006 Guest Lecture 3

Stephen Kinsella | Stephen.kinsella@ul.ie | www.stephenkinsella.net

LAST TIMEWhether wage reductions stimulate output depends on changes in effective demand and the ratio of levels of rK: wN: rL Changing wN dents domestic consumption and probably won’t increase competitiveness in short run.

It’s clear we want to change effective demand to increase X/Y.

What changes effective demand (again, determined by Factor Cost+User Cost)

MEC (sort of) + Liq. Preferences + changes in User cost.

Support people with no money but a good idea, you change User cost.

TODAY

TODAYFISCAL

STIMULUS

TODAYFISCAL

STIMULUS

MULTIPLIERS

TODAYFISCAL

STIMULUS

MULTIPLIERS

IMP

LEM

EN

TA

TIO

N

& M

EA

SUR

EM

EN

T

IRISH GOVTSPENDING

79bn on:

25%

35%

39%

Public Sector Pay & PensionsTransfersOther Stuff

IN TODAY’S NEWS• NESC (see website) have written a report on our 5 fold crisis:

1.A banking crisis

2.A fiscal crisis

3.An economic crisis

4.A social crisis

5.A reputational crisis

MEASURING FISCAL STIMULUS

Fiscal what?

Budget on April 17th

Let’s talk about consumption.

RECALL

The multiplier is the number that relates the initial increase in expenditure to the final change in GNP (when all rounds have been taken into account).

Size of the multiplier depends on the following 3 leakages: savings, taxation and imports.

Ignore the tax and import leakages for the moment.

RECALLConsumption function: C = MPC × NI

MPC = marginal propensity to consume.

0 < MPC ≤ 1

Savings function: S = MPS × NI

MPS = marginal propensity to save.

0 ≤ MPS < 1.

The MPC and MPS must add up to one.

1 = MPC + MPS

RECALLCan be shown:

Multiplier = 1/(1 - MPC) or 1/MPS

Example: MPC Multiplier

0.9 10

0.8 5

Final change

in GNP = Multiplier x Initial Expenditure

€5b = 5 × €1b

AND FINALLY…Define:

T = MPT × NI

Where T = taxation and MPT is the marginal propensity to tax.

M = MPM × NI

Where M = imports and MPM is the marginal propensity to import.

Can be shown:

Multiplier = 1/(MPS + MPT + MPM)

IRELAND’S MULTIPLIEREstimates for the Irish economy are

MPS = 0.2 and rising

MPT = 0.3

MPM = 0.4

Multiplier = 1.11

Small due to the relatively high combined tax and import leakages.

For the UK and US economies the multiplier is closer to 3.5. Due to low taxes and relatively “closed” economies.

NOW FOR SOMETHING COMPLETELY DIFFERENT….

BUDGET PROBLEM: ACCOUNTING METHODS

BUDGET PROBLEM: ACCOUNTING METHODS

Irish budgets are cash flow budgets, a budget where revenues and expenses are counted only when cash is received and spent.

BUDGET PROBLEM: ACCOUNTING METHODS

Irish budgets are cash flow budgets, a budget where revenues and expenses are counted only when cash is received and spent.

An obligation budget includes the expected value of future expenditures and revenues.

BUDGET PROBLEM: ACCOUNTING METHODS

Irish budgets are cash flow budgets, a budget where revenues and expenses are counted only when cash is received and spent.

An obligation budget includes the expected value of future expenditures and revenues.

Which one is more appropriate for considering the fiscal impact of the deficit?

BUDGET PROBLEM: ACCOUNTING METHODS

Irish budgets are cash flow budgets, a budget where revenues and expenses are counted only when cash is received and spent.

An obligation budget includes the expected value of future expenditures and revenues.

Which one is more appropriate for considering the fiscal impact of the deficit?

Predicting revenues and expenses.

UNCERTAINTY ABOUT POTENTIAL OUTPUT

UNCERTAINTY ABOUT POTENTIAL OUTPUT

One macroeconomic policy goal is to keep output as close to potential as possible. But, what is potential output?

UNCERTAINTY ABOUT POTENTIAL OUTPUT

One macroeconomic policy goal is to keep output as close to potential as possible. But, what is potential output?

If policymakers use contractionary policy when the economy is actually below potential, they create ‘unnecessary’ unemployment.

UNCERTAINTY ABOUT POTENTIAL OUTPUT

One macroeconomic policy goal is to keep output as close to potential as possible. But, what is potential output?

If policymakers use contractionary policy when the economy is actually below potential, they create ‘unnecessary’ unemployment.

Using expansionary policy above potential output will cause inflation.

POLICY IMPLEMENTATION LAG

POLICY IMPLEMENTATION LAG

The policy implementation lag is the delay between the time policy makers recognize the need for a policy action and when the policy is instituted.

POLICY IMPLEMENTATION LAG

The policy implementation lag is the delay between the time policy makers recognize the need for a policy action and when the policy is instituted.

Irish fiscal policy has a long implementation lag relative to other OECD countries.

POLICY IMPLEMENTATION LAG

The policy implementation lag is the delay between the time policy makers recognize the need for a policy action and when the policy is instituted.

Irish fiscal policy has a long implementation lag relative to other OECD countries.

Monetary policy has a much shorter implementation lag because the ECB decides monetary policy and implements it immediately.

SOOO....