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Fiscal Policy Changes in federal taxes and purchases

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Fiscal Policy. Changes in federal taxes and purchases . Where does the government spend its money?. Federal Government Spending, 2010. Fiscal Policy. An Overview of Government Spending and Taxes. The Federal Government’s Share of Total Government Expenditures, 1929–2009. Fiscal Policy. - PowerPoint PPT Presentation

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Page 1: Fiscal Policy

Fiscal PolicyChanges in federal taxes and purchases

Page 2: Fiscal Policy

Where does the government spend its money?

Federal Government Spending, 2010

Page 3: Fiscal Policy

Fiscal PolicyAn Overview of Government Spending and Taxes

The Federal Government’s Share of Total Government Expenditures, 1929–2009

Page 4: Fiscal Policy

Fiscal PolicyAn Overview of Government Spending and Taxes

Federal Purchases and Federal Expenditures as a Percentage of GDP, 1950–2010

Page 5: Fiscal Policy

Where does the government get its money?

Federal Government Revenue, 2010

Page 6: Fiscal Policy
Page 7: Fiscal Policy

Laffer Curve (not in the book): there is optimal amount of taxation

Tax

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Page 8: Fiscal Policy

Government spending/taxes and aggregate demand

Page 9: Fiscal Policy

The Effects of Fiscal Policyon Real GDP and the Price Level

Expansionary and Contractionary Fiscal Policy: An Initial Look

Page 10: Fiscal Policy

Using Fiscal Policy to Influence Aggregate Demand: A More Complete Account

An Expansionary Fiscal Policy

Page 11: Fiscal Policy

Using Fiscal Policy to Influence Aggregate Demand: A More Complete Account

A Contractionary Fiscal Policy

Page 12: Fiscal Policy

A Summary of How Fiscal Policy Affects Aggregate Demand

Countercyclical Fiscal Policy

PROBLEM TYPE OF POLICYACTIONS BY CONGRESS AND THE PRESIDENT RESULT

Recession Expansionary Increase government spending or cut taxes

Real GDP and the price level rise.

Rising Inflation Contractionary Decrease government spending or raise taxes

Real GDP and the price level fall.

Don’t Let This Happen to YOU!Don’t Confuse Fiscal Policy and Monetary Policy

Page 13: Fiscal Policy

Multiplier (again)

Page 14: Fiscal Policy

The Government Purchases and Aggregate Demand

The Multiplier Effect and Aggregate Demand

Page 15: Fiscal Policy

Taking into Account the Effects of Aggregate Supply

The Multiplier Effect and Aggregate Supply

Page 16: Fiscal Policy

The Government Purchases and Tax Multipliers

The Multiplier Effect of an Increase in Government Purchases

Page 17: Fiscal Policy

Change in equilibrium real GDPGovernment purchases multiplierChange in government purchases

Change in equilibrium real GDPTax multiplierChange in taxes

The Government Purchases and Tax Multipliers

The ratio of the change in equilibrium real GDP to the initial change in government purchases is known as the government purchases multiplier:

The expression for the tax multiplier is:

Page 18: Fiscal Policy

A cut in tax rates affects equilibrium real GDP through two channels:

(1) A cut in tax rates increases the disposable income of households, which leads them to increase their consumption spending, and

(2) a cut in tax rates increases the size of the multiplier effect.

Page 19: Fiscal Policy

Decrease and increases in government expenditure are multiplied

Decrease and increase in taxes are multiplied

The Multipliers Work in Both Directions

Page 20: Fiscal Policy

Solved ProblemFiscal Policy Multipliers

Briefly explain whether you agree or disagree with the following statement: “Real GDP is currently $12.2 trillion, and potential real GDP is $12.5 trillion. If Congress and the president would increase government purchases by $300 billion or cut taxes by $300 billion, the economy could be brought to equilibrium at potential GDP.”

Change in equilibrium real GDPGovernment purchases multiplierChange in government purchases

Page 21: Fiscal Policy

Crowding outA decline in private expenditures as a result of

an increase in government purchases.

Page 22: Fiscal Policy

Crowding out limits Fiscal Policy in the short run.

Crowding Out in the Money Market

An Expansionary Fiscal Policy Increases Interest Rates

Page 23: Fiscal Policy

In the long run, the economy returns to potential GDP.

Crowding Out in the Aggregate Demand and Aggregate Supply Diagram

Page 24: Fiscal Policy

Budget DeficitBudget deficit The situation in which the government’s expenditures are greater than its tax revenue.

Budget surplus The situation in which the government’s expenditures are less than its tax revenue.

Page 25: Fiscal Policy

Deficits, Surpluses, and Federal Government Debt

The Federal Budget Deficit, 1901–2009

Page 26: Fiscal Policy

Solved ProblemThe Effect of Economic Fluctuations on the Budget Deficit

The federal government’s budget deficit was $207.8 billion in 1983 and $185.4 billion in 1984. A student comments, “The government must have acted during 1984 to raise taxes or cut spending or both.” Do you agree? Briefly explain.

Page 27: Fiscal Policy

Cyclically adjusted budget deficit or surplus: The deficit or surplus in the federal government’s budget if the economy were at potential GDP.

Deficits, Surpluses, and Federal Government Debt

How the Federal Budget Can Serve as an Automatic Stabilizer

Page 28: Fiscal Policy

Debt can be a problem for a government for the same reasons that debt can be a problem for a household or a business.

Deficits, Surpluses, and Federal Government Debt

Is Government Debt a Problem?

Page 29: Fiscal Policy

Although many economists believe that it is a good idea for the federal government to have a balanced budget when the economy is at potential GDP, few economists believe that the federal government should attempt to balance its budget every year.

Deficits, Surpluses, and Federal Government Debt

Should the Federal Budget Always Be Balanced?

Page 30: Fiscal Policy

•Did Fiscal Policy Fail during the Great Depression?

Makingthe

Connection

Although government spending increased during the Great Depression, the cyclically adjusted budget was in surplus most years.

FEDERAL GOVERNMENT

EXPENDITURES (BILLIONS OF

DOLLARS

ACTUALFEDERAL BUDGET DEFICIT

OR SURPLUS (BILLIONS OF

DOLLARS)

CYCLICALLY ADJUSTED

BUDGET DEFICIT OR SURPLUS (BILLIONS OF

DOLLARS)

CYCLICALLY ADJUSTED

BUDGET DEFICIT OR SURPLUS AS A PERCENTAGE

OF GDP

1929 $2.6 $1.0 $1.24 1.20%

1930 2.7 0.2 0.81 0.89

1931 4.0 -2.1 -0.41 -0.54

1932 3.0 -1.3 0.50 0.85

1933 3.4 -0.9 1.06 1.88

1934 5.5 -2.2 0.09 0.14

1935 5.6 -1.9 0.54 0.74

1936 7.8 -3.2 0.47 0.56

1937 6.4 0.2 2.55 2.77

1938 7.3 -1.3 2.47 2.87

1939 8.4 -2.1 2.00 2.17

Page 31: Fiscal Policy

Tax wedge The difference between the pretax and posttax return to an economic activity.

The Effects of Fiscal Policy in the Long Run

The Long-Run Effects of Tax Policy

• Individual income tax.• Corporate income tax.• Taxes on dividends and capital gains.

We can look briefly at the effects on aggregate supply of cutting each of the following taxes:

In addition to the potential gains from cutting individual taxes, there are also gains from tax simplification.

Tax Simplification

Page 32: Fiscal Policy

The Effects of Fiscal Policy in the Long Run

The Economic Effect of Tax ReformThe Supply-Side Effects of a Tax Change

Page 33: Fiscal Policy

Most economists would agree that there are supply-side effects to reducing taxes: Decreasing marginal income tax rates will increase the quantity of labor supplied, cutting the corporate income tax will increase investment spending, and so on.

The magnitude of the effects is subject to considerable debate, however.

The Effects of Fiscal Policy in the Long Run

How Large Are Supply-Side Effects?