fiscal policy sfls online

PowerPoint Presentation

Price levelGDP

AD

SRAS

PE

LRAS

YN0AD/AS ModelStart with a little review, this is all about the government ways to adjust the AD curve

11

Aggregate Supply A Recap

Price levelGDP

LRASY0

SRASAggregate Supply is: vertical in long run nominal changes do not affect real variables

upward-sloping in short run nominal changes do affect real variables

22The book does not use the notation YN. I use it here to keep the slides from getting too cluttered, and also to make it easier for students to take notes: its easier for them to write YN than the natural rate of output.

Why the AD Curve Slopes Downward

PY

ADP1Y1

P2

Y2Y10Y = C + I + G + (X M) This equation will be about the shape of the curve, and the change in each piece of the equation will shift the curve

33

Aggregate DemandAD/AS ModelY = C + I + G + (X M) Y = C + I + G + NX or

Ceteris Paribus:When the P level rises, the Q of real GDP demanded decreases.When the P level falls, the Q of real GDP demanded increases.

AD/AS ModelY = C + I + G + (X M) C = consumption of G&S in an economy.Aggregate DemandIt is typically the largest part of an economy

AD/AS ModelY = C + I + G + (X M) C = consumption of G&S in an economy.I = investment of Capital in an economy.

Aggregate DemandNot stocks and bonds!


G = government spending net after taxes.

Aggregate DemandNow = Ceteris Paribus, governments try to control the economy, a topic for later


G = government spending net after taxes.

Aggregate DemandX-M = exports -imports net exports.NX

Aggregate Demand (AD)Reasons for the Slope of AD

Aggregate Demand A Recap 1.) The Wealth Effect (C shifts)2.) The Interest-Rate Effect (I shifts)3.) Government spending4.) The Exchange-Rate Effect (NX shifts)

Change in purchasing power

The Wealth Effect (P and C )AD = C + I + G + (X M) Change in desire to invest

The Interest-Rate Effect (P and I )Assume Ceteris Paribus for nowGovernment spendingChanges of value of money on FOREX change imports and exports.

The Exchange-Rate Effect (P and NX )Aggregate Demand A Recap

The Slope of the AD Curve: SummaryAn increase in P reduces the quantity of G&S demanded because:

PY

AD

P1Y1the wealth effect (C falls)

P2

Y2

the interest-rate effect (I falls)the exchange-rate effect (NX falls)0

1111Note that the red arrow is not equal to the fall in C, but rather to the fall in demand due to the fall in C. The difference is due to the Keynesian multiplier: the initial fall in C causes a fall in Y, which causes a further (but smaller) fall in C, which causes a further (but smaller) fall in Y, and so forth. It might not be appropriate to cover the Keynesian multiplier at this point it will be discussed in the following chapter but mentioning that the red arrow is not the same as the fall in C might prevent students from learning something they will later have to unlearn. Similarly, the green arrow represents not the fall in I, but the fall in demand due to the fall in I. And similarly for the goldish-brown arrow and NX.

Aggregate Demand (AD)Shifts

Aggregate Demand A Recap 1.) The Wealth Effect (C shifts)2.) The Interest-Rate Effect (I shifts)3.) Government spending4.) The Exchange-Rate Effect (NX shifts)

Why the AD Curve Might ShiftAny event that changes C, I, G, or NX except a change in P will shift the AD curve.

PY

AD1

AD2Y2

P1

Y1

0Aggregate Demand A Recap

1313A change in P wont shift the AD curve, but will cause a movement along the AD curve.

AD = C + I + G + (X M)

Time for the G!

Assume Ceteris Paribus for nowGovernment spendingAggregate Demand TheoriesY = C + I + G + (X M)

Assume Ceteris Paribus for nowGovernment spendingAggregate Demand TheoriesY = C + I + G + (X M)

Government spendingAssume Ceteris Paribus for nowWe will now refer to this as

- is the use of the federal budget to sustain economic growth and smooth the business cycle.Fiscal PolicyFiscal Policy AD = C + I + G + (X M)

- Basically, fiscal policy aims to stabilize economic growth, avoiding a boom and bust economic cycle.

0

Time

Long Run

Short RunIn the short run things go up and down and can be quite volatileBusiness CycleEcon Growth - is the use of the federal budget to sustain economic growth and smooth the business cycle.Fiscal Policy

1818

0

Time

Long Run

Short Run

Business CycleEcon Growth - is the use of the federal budget to sustain economic growth and smooth the business cycle.Fiscal PolicyThe goal is to make the short run less volatile

1919

Macro Economic Goals1.) Full employmentAbout 5% unemployment2.) Stability (Prices) 3.) Economic growth 4.) Balance of Payments Equilibrium About 2% inflationAbout 3% growth (7% in China)Keep trade deficits low, but no percentage number as a guide

Macro Economic Goals1.) Full employmentAbout 5% unemployment2.) Stability (Prices) 3.) Economic growth 4.) Balance of Payments Equilibrium About 2% inflationAbout 3% growth (7% in China)Keep trade deficits low, but no percentage number as a guideThe focus is to make these first three goals stable around these figures typically

- is the use of the federal budget to sustain economic growth and smooth the business cycle.Fiscal PolicyFiscal Policy AD = C + I + G + (X M)

- is the use of taxes, government transfers, or government purchases of goods and services to shift the AD curve.Reworded definition:

AD = C + I + G + (X M)

Types of Fiscal Policy

- An increase in government spending or decrease in taxes to increase ADExpansionary Fiscal PolicyTypes of Fiscal Policy AD = C + I + G + (X M)

Inflationary Fiscal Policyor Government spending Taxes ***Ceteris ParibusDefinition with arrows: Shifts AD right

or / and

An decrease in government spending or increase in taxes to decrease ADContractionary Fiscal PolicyTypes of Fiscal Policy AD = C + I + G + (X M)

Deflationary Fiscal Policyor Government spending Taxes ***Ceteris ParibusDefinition with arrows: Shifts AD left

or / and

Expansionary Fiscal Policy

Expansionary Fiscal PolicyAD = C + I + G + (X M)

Government spending

Price levelGDP

AD

SRAS

PE

LRAS

YN

Y1

P1

AD1


Government spending

Price levelGDP

AD

SRAS

PE

LRAS

YN

Y1

P1

AD1

(C) also increases due to the multiplier, which we will discuss later.


Taxes

Price levelGDP

AD

SRAS

PE

LRAS

YN

Y1

P1

AD1


Taxes

Price levelGDP

AD

SRAS

PE

LRAS

YN

Y1

P1

AD1

(C) And (I) increases because of more disposable income which has a different multiplier, which we will discuss later

0

Time

Long Run

Short RunEcon Growth - is the use of the federal budget to sustain economic growth and smooth the business cycle.Fiscal Policy

Use Contractionary Fiscal PolicyUseExpansionary Fiscal Policy

3030

AD = C + I + G + (X M)

How Fiscal Policy is done Expansionary and Contractionary Policies have two general ways they are accomplished.

- based on the subjective judgment of policymakers in the moment to an attempt to directly affect the economy

Discretionary Fiscal PolicyAD = C + I + G + (X M)

Examples: - New Laws or Legislation

- Can be about larger issues then just the economy, such as judicial and social issues

How Fiscal Policy is done

Italy has a new policy that many new building should have green roofs. This has an economic consequence of course as well as an environmental.




- New jobs programs / public works


Great Depression 1930s

In the 1930s as an example, the US government started programs to help get people back to work.

John Maynard Keynes, 5 June 1883 21 April 1946) was a British economist whose ideas have fundamentally affected the theory and practice of modern macroeconomics, and informed the economic policies of governments. He is widely considered to be one of the founders of modern macroeconomics and the most influential economist of the 20th century Following this guys ideas about government intervention more or less.




- New jobs programs / public works

How Fiscal Policy is done - Issue new Bonds

- A set of laws or legislation that occurs and has an immediate response without any official or government body having to take action.


Automatic Stabilizers How Fiscal Policy is done



Examples:

Automatic Stabilizers - Progressive Taxes


40Types of TaxesDirect TaxesTaxes based on ownership.Paid directly to the government by people.

Example:Income taxes, property taxes.Indirect TaxesTaxes paid on a market transaction.Sellers usually pay to the government.

Example:sales taxes, VAT taxes.

Last year we studied indirect taxes in the market and how they tend to be regressive.

41Types of TaxesDirect TaxesTaxes based on ownership.Paid directly to the government by people.

Example:Income taxes, property taxes.Indirect TaxesTaxes paid on a market transaction.Sellers usually pay to the government.

Example:sales taxes, VAT taxes.The taxes mentioned here are direct taxes on income and tend to be progressive.

Regressive Taxes

Poor

Rich

Average

A tax whose average rate decreases as income increases.

pay10%

pay6%

pay2%

Proportional Taxes

Poor

Rich

Average

A tax whose average rate is constant at all income levels.

pay10%

pay10%

pay10%

Progressive Taxes

Poor

Rich

Average

A tax whose average rate increases as income increases.

pay10%

pay15%

pay20%

Progressive Taxes

Poor

Rich

Average

A tax whose average rate increases as income increases.

pay10%

pay15%

pay20%

Higher incomes pay more, lower incomes pay less, which automatically adjusts with the business cycle.



Automatic Stabilizers - Unemployment Benefits

Examples:

- Progressive Taxes


Unemployment lineDuring good times, less people ask for help.

Unemployment lineDuring bad times, more people ask for help and automatically adjust the amount of benefits with the business cycle.



Automatic Stabilizers - Unemployment Benefits

Examples:

- Progressive Taxes

How Fiscal Policy is done - New laws with permeant spending requirements

In the US, as an example there are also health benefits that work on a similar idea as the unemployment benefits.

Medicare is health care for lower income people, during bad times more people often need it.

Social Security is similar for older and retired people. You can get income assistance after reaching a certain age.

0

Time

Long Run

Short RunBusiness CycleEcon Growth - is the use of the federal budget to sustain economic growth and smooth the business cycle.Fiscal PolicyAll these things should smooth out this cycle.

5353

AD = C + I + G + (X M)

Resources to do Fiscal Policy

annual expenditures and tax receipts of the government. Fiscal PolicyFiscal Policy AD = C + I + G + (X M)

Fiscal Budget

Notice that more the half the budget is for social security and medicare.

These are automatically spent

Which leaves much less for discretionary spending

See this grey slice?

This is payment on old debts, this becomes a problem with borrowing money because your paying back old debts and have less to spend today.


Fiscal Budget- if expenditures exceeds tax receipts. Budget Deficit

>

Throughout the post world war two period in the US, its much more common to have budget deficits then surpluses.

That means this grey slice become bigger and hurts long term growth.


Fiscal Budget- if expenditures exceeds tax receipts. Budget Deficit

>- if tax receipts exceeds expenditures. Budget Surplus>


Fiscal Budget- if expenditures exceeds tax receipts. Budget Deficit>- if tax receipts exceeds expenditures. Budget Surplus>

- if tax receipts equals expenditures. Balanced Budget=

Insert a Government Balance Budget graph hereReally, really, really, hard to find good examples of governments doing this today.

Fiscal Policy AD = C + I + G + (X M)

Fiscal BudgetBudget Deficit vs. Budget SurplusThe government borrows to finance a budget deficit and repays its debt when it has a budget surplus.The amount of debt outstanding that arises from past budget deficits is called national debt.

AD = C + I + G + (X M)

Fiscal PolicyBudget Deficit Problems:

AD = C + I + G + (X M)

Budget Deficit Problem:Crowding out:Government spending and borrowing that may fail to increase AD and hurts private investment.When the government has to borrow, it needs to borrow from the private sector. This could be private individuals, pension funds or investment trusts. It is argued that if the private sector buy government securities this will crowd out private sector investment.

AD = C + I + G + (X M)

Budget Deficit Problem:Crowding out:Typically this deals with the increase of interest rates due to attempting to sell more bonds to finance debtWhen the government has to borrow, it needs to borrow from the private sector. This could be private individuals, pension funds or investment trusts. It is argued that if the private sector buy government securities this will crowd out private sector investment.Government spending and borrowing that may fail to increase AD and hurts private investment.

AD = C + I + G + (X M)

Budget Deficit Problem:Long term debt:Borrowed money has to be paid back with interest over time meaning to total costs will be higher.Crowding out:Future budgets will have less discretionary spending ability due to having to pay back old loans

AD = C + I + G + (X M)

Fiscal Policy Limitations

Discretionary Fiscal PolicyLimitations:- Political conflicts

Keynesians vs. Monetarists, vs. Conservatives Automatic Stabilizers Fiscal Policy Limitations

John Maynard Keynes, 5 June 1883 21 April 1946) was a British economist whose ideas have fundamentally affected the theory and practice of modern macroeconomics, and informed the economic policies of governments. He is widely considered to be one of the founders of modern macroeconomics and the most influential economist of the 20th century

John Maynard Keynes, 5 June 1883 21 April 1946) was a British economist whose ideas have fundamentally affected the theory and practice of modern macroeconomics, and informed the economic policies of governments. He is widely considered to be one of the founders of modern macroeconomics and the most influential economist of the 20th century In the long run we are all dead! Spend the money and fix our problems TODAY!

Friedrich August Hayek (German; 8 May 1899 23 March 1992), born in Austria-Hungary as Friedrich August von Hayek and frequently known as F. A. Hayek, was an Austrian, later British, economist and philosopher best known for his defense of classical liberalism. In 1974, Hayek won the Nobel Memorial Prize in Economic.

Friedrich August Hayek (German; 8 May 1899 23 March 1992), born in Austria-Hungary as Friedrich August von Hayek and frequently known as F. A. Hayek, was an Austrian, later British, economist and philosopher best known for his defense of classical liberalism. In 1974, Hayek won the Nobel Memorial Prize in Economic.In the long run, its your theory that is dead! Your going to hurt growth and cause bigger problems!

Milton Friedman (1912 2006) was an American economist, statistician, and writer who taught at the University of Chicago. He won the Nobel Prize in Economics, and is known for his research on consumption analysis, monetary history and theory , and the complexity of stabilization policy.

Milton Friedman (1912 2006) was an American economist, statistician, and writer who taught at the University of Chicago. He won the Nobel Prize in Economics, and is known for his research on consumption analysis, monetary history and theory , and the complexity of stabilization policy.I also dont totally agree with Keynes. Governments are not the best solution and the money supply is more important and useful!

Discretionary Fiscal PolicyLimitations:- Political conflicts

Automatic Stabilizers By time policy is enacted the economy may have changed- Time lags


Tax cuts for example, dont happen all of a sudden. It takes time for the system to react to them.

Discretionary Fiscal PolicyLimitations of both :- Political conflicts

Automatic Stabilizers - Time lags

Leads to poor decisions- Poor information




- Poor information

Stops domestic investment and possible increases costs to borrow- Crowding out




- Poor information

- Crowding out

- Cause deficit / debt problems

Fiscal Policy LimitationsLong term consequences of lower growth



- Poor information

- Crowding out


Fiscal Policy LimitationsHow to reduce spending later? Programs dont go away- Governments can be inefficient

{



- Poor information

- Crowding out


Fiscal Policy Limitations- Governments can be inefficient changes the effectiveness- Depends on the size of the multiplier

That is it for nowThank you

fiscal policy sfls online

Education