ModuleEconomic Policy and the Aggregate Demand-Aggregate Supply Model

odelKRUGMAN'S

MACROECONOMICS for AP*

20

Margaret Ray and David Anderson

What you will learnWhat you will learn

in thisin this ModuleModule::

• How the AD-AS model is used to formulate macroeconomic policy

• The rationale for stabilization policy

• Why fiscal policy is an important tool for managing economic fluctuations

• Which policies constitute expansionary fiscal policy and which constitute contractionary fiscal policy

1. 20th century British economist.

2. Economic Consequences of the Peace, General Theory of Employment, Interest and Money

3. Adviser at Versailles peace conference.

4. Ballerina

5. Stock and commodity investor.

Keynes QuizKeynes Quiz

• Self-correction?

• “In the long-run, we all are dead.”

• Stabilization Policy

• Monetary

• Fiscal (budget)

Macroeconomic PolicyMacroeconomic Policy

Fiscal policy in USA developed in the 1930s, was formalized in the 1960s and continues today.

Paul Solomon on Fiscal PolicyPaul Solomon on Fiscal Policy

Policy in the Face of Policy in the Face of Demand ShocksDemand Shocks

• Negative Demand Shocks & Positive Demand Shocks

• Why are they bad?

• Should policymakers counteract?

Responding to Supply Responding to Supply ShocksShocks

• Supply shock

• Policy dilemma

The Government Budget and Total The Government Budget and Total SpendingSpending

• GDP = C + I + G + X - M

• The effect of taxes and transfers

• Effects on Investment

Fiscal ToolsFiscal Tools

• Spending

• Taxes

• Transfers

Expansionary and Expansionary and Contractionary Fiscal PolicyContractionary Fiscal Policy

• Expansionary Fiscal Policy

• increase G

• decrease taxes

• increase transfers

Expansionary and Expansionary and Contractionary Fiscal PolicyContractionary Fiscal Policy

• Contractionary Fiscal Policy

• decrease G

• increase taxes

• decrease transfers

Fiscal Policy PracticeFiscal Policy Practice

• Activity 30 -31

• Left side – even questions

• Right side - odds

How sharp are the fiscal tools?How sharp are the fiscal tools?

1. How are taxes related to GDP?

2. How is spending related to GDP?

3. How much of spending is mandatory

4. vs. discretionary?

5. How easy is it to change taxes ….

6. or spending?

Federal Government RevenueFederal Government Revenue

GDP = $17 trillion, Federal revenue $2.9 trillion

Taxes, Government Purchases of Goods Taxes, Government Purchases of Goods and Services, Transfers, and Borrowingand Services, Transfers, and Borrowing

GDP = $17 trillion, Federal spending $3.8 trillion

Fiscal Policy On AutopilotFiscal Policy On Autopilot

• Automatic Stabilizers

• Recession: taxes down, transfers up

• Inflation: taxes up, transfers same or higher

A Cautionary Note: Lags in Fiscal A Cautionary Note: Lags in Fiscal PolicyPolicy

Time lags

•Recognition lag

•Decision lag

•Implementation lag

•Lags make decision making more difficult

Summary Summary

• Expansionary vs. contractionary

• Three fiscal tools

• Automatic stabilizers

• Limitations on fiscal policy

• Time lags

• Mandatory spending = 60% budget

Exit TicketExit Ticket

• Imagine the economy is slipping back into recession.

• You are on the Council of Economic Advisors (student representative). Write a quick note to the president on the pros and cons of:

• Doing nothing.

• Actively pursuing fiscal policy.

Visualizing the U.S. Budget Visualizing the U.S. Budget

The U.S. Budget - A Visual Perspective - YouTube