Lecture Macroeconomics - Chapter 10: Fiscal policy

In chapter 10 you will learn: What fiscal policy is and what it is used for; what discretionary fiscal policy is and its function; about the economy’s built-in stabilizers; what a cyclically adjusted budget is; the problems, criticisms, and complications of fiscal policy.

FISCAL POLICY CHAPTER 10 SLIDES PREPARED BY JUDITH SKUCE, GEORGIAN COLLEGE © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 10 In this chapter you will learn What fiscal policy is and what it is used for What discretionary fiscal policy is and its function About the economy’s built-in stabilizers What a cyclically adjusted budget is The problems, criticisms, and complications of fiscal policy © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 10 Chapter 10 Topics Legislative Mandates Fiscal Policy & the AD-AS Model Built-In Stabilization Evaluating Fiscal Policy Problems, Criticisms & Complications © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 10 Legislative Mandates Great Depression need for stabilization role Unemployment Insurance introduced during World War II Governments regularly use fiscal policy to stabilize the economy © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 10 Chapter 10 Topics Legislative Mandates Fiscal Policy & the AD-AS Model Built-In Stabilization Evaluating Fiscal Policy Problems, Criticisms & Complications © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 10 Discretionary Fiscal Policy Definition: Deliberate changes of – government expenditures – taxes Dependent upon deliberate decisions in Parliament © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 10 Discretionary Fiscal Policy Expansionary Fiscal Policy Recessionary Gap Options: Increase Government Spending Decrease Taxes Some Combination of the Two © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 10 Expansionary Fiscal Policy Figure 10-1 Price level AS PL0 AD0 recessionary gap GDP0 GDPf Real GDP (billions) © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 10 Expansionary Fiscal Policy Figure 10-1 Price level AS PL1 PL0 AD1 AD0 GDP0 GDPf Real GDP (billions) © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 10 Discretionary Fiscal Policy Contractionary Fiscal Policy Inflationary Gap Options: Decrease Government Spending Increase Taxes Some Combination of the Two © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 10 10 Cyclically Adjusted Budget G, T 500 475 450 425 Figure 10-4 $25 billion T1 deficit due to the cyclically expansionary T2 adjusted deficit is fiscal policy zero in year G taxes are reduced $50 billion deficit due to economy enters a recession recession in year GDP4 GDP3 real GDP (year 4) (year 3) fullemployment © 2002 McGraw-Hill Ryerson Ltd GDP Macroeconomics, Chapter 10 23 Recent Canadian Fiscal Policy neutral to mildly expansionary in the early 1990s contractionary in later years actual deficits have given way to actual surpluses © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 10 24 Chapter 10 Topics Legislative Mandates Fiscal Policy & the AD-AS Model Built-In Stabilization Evaluating Fiscal Policy Problems, Criticisms & Complications © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 10 25 Problems, Criticisms, & Complications Problems of Timing – Recognition Lag – Administration Lag – Operational Lag A Political Business Cycle? Offsetting Provincial & Municipal Finance © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 10 26 Problems, Criticisms, and Complications Crowding-Out Effect expansionary fiscal policy higher interest rates reduction in interest-sensitive spending may not be significant in a recession fiscal policy can be accommodated by increases in money supply © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 10 27 Problems, Criticisms, and Complications some portion of the potential effect of expansionary fiscal policy may be dissipated in the form of inflation illustrate d… © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 10 28 Fiscal Policy, AS & Inflation Figure 10-5 AD1 Price level AD0 AS PL2 PL1 GDP0 GDP1 GDPf Real GDP (billions) © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 10 29 Fiscal Policy, AS & Inflation Figure 10-5 AD1 Price level AD0 AS price level rises GDP increases only to GDP1 PL2 PL1 GDP0 GDP1 GDPf Real GDP (billions) © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 10 30 Fiscal Policy in the Open Economy Shocks Originating from Abroad Net Export Effect… © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 10 31 Table 10-1 recession expansionary fiscal policy higher domestic interest rates increased foreign demand for C$ C$ appreciates net exports fall partial offset to expansionary fiscal policy © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 10 32 Table 10-1 inflation contractionary fiscal policy lower domestic interest rates decreased foreign demand for C$ C$ depreciates net exports rise partial offset to contractionary fiscal policy © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 10 33 Supply-Side Fiscal Policy tax changes may alter aggregate supply & affect the results of fiscal policy – saving & investment – work incentives – risk-taking examine the effects of a tax cut… © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 10 34 Supply-Side Fiscal Policy Figure 10-6 Price level AS1 AS2 PL2 PL3 PL1 AD2 AD1 GDP GDP GDP Real GDP 1(billions) © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 10 35 Supply-Side Fiscal Policy most economists are skeptical about the supply-side effects of tax cuts – weak effects – timing © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 10 36 Chapter 10 Topics Legislative Mandates Fiscal Policy & the AD-AS Model Built-In Stabilization Evaluating Fiscal Policy Problems, Criticisms & Complications © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 10 37 ... of fiscal policy © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 10 Chapter 10 Topics Legislative Mandates Fiscal Policy & the AD-AS Model Built-In Stabilization Evaluating Fiscal Policy. .. regularly use fiscal policy to stabilize the economy © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 10 Chapter 10 Topics Legislative Mandates Fiscal Policy & the AD-AS Model Built-In Stabilization... government © 2002 McGraw-Hill Ryerson Ltd Macroeconomics, Chapter 10 13 Chapter 10 Topics Legislative Mandates Fiscal Policy & the AD-AS Model Built-In Stabilization Evaluating Fiscal Policy Problems,