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1. Define Fiscal Policy?
2. What is NOT fiscal policy?
3. What is an expansionary fiscal policy, and what is a contractionary fiscal policy?
Visualize
4. What are the two effects that fiscal policy has on AD?
1. Changes in federal taxes and purchases that are intended to achieve macroeconomic policy objectives.
2. Economists generally use the term fiscal policy to refer only to the actions of the federal government. Provincial, territorial, and local governments sometimes use their ability to tax and spend to aid their local economies, but only the federal government is focused on the economy of the whole country
3. Expansionary fiscal policy is an increase in G and/or decrease in T that shifts AD right
- Contractionary fiscal policy is a decrease in G and/or increase in T that shifts AD left
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4a. Multiplier effect
b. Crowding-out effect
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1. What percentage of economic activity did government spending (G) account for in 2012?
2. What 2 reasons explain why over the past 50 years, federal government spending has been declining while provincial spending has been rising?
3. What are the top Federal Government expenditures?
1. 40 percent. *An increasing amount on health care*
2a.The federal government has been delegating the administration of certain responsibilities to provincial and territorial agencies (e.g., the regulation of interprovincial and international highway traffic, and the management of forestry and natural resources)
b.The importance of health care in the budgets of other levels of government has grown
- 3. Name some of the top federal government expenditures and their percentages
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- 4. Name some of the top federal government revenues and their percentages
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1. What is major way government uses taxes to pursue an expansionary fiscal policy?
2. Why would policy makers use contractionary fiscal policy?
3. What problem does expansionary fiscal policy try to solve, by what methods and what is the result?
4. What problem does contractionary fiscal policy try to solve, by what methods and what is the result?
- 1. Cutting the individual income tax will increase household disposable income,
- the income households have available to spend after they have paid their taxes, and consumption spending.
2. To reduce increases in aggregate demand that seem likely to lead to inflation.
3. Expansionary fiscal policy used to get an economy out of a recession by increasing government spending and/or cutting taxes. It results in a rise in real GDP and the price level.
4. Contractionary fiscal policy used to reduce inflation by decreasing government spending and/or raising taxes. It results in a fall in real GDP and the price level.
- **This is assuming that we are holding constant monetary policy and all other factors affecting the variables involved.
- ceteris paribus
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1. What is the multiplier effect?
2. Give an example of how the multiplier effect works using Boeing
3. How would you explain this in terms of G, C and Y? Visualize
4. What determines how large the multiplier effect will be?
1. Multiplier effect: the additional shifts in AD that result when fiscal policy increases income and thereby increases consumer spending
- 2. If the govt buys $20b of planes from Boeing, Boeing’s revenue increases by $20b.
- This is distributed to Boeing’s workers (as wages) and owners (as profits or stock dividends).
- These people are also consumers, and will spend a portion of the extra income.
- This extra consumption causes further increases in aggregate demand.
3. A $20b increase in G initially shifts AD to the right by $20b.
The increase in Y causes C to rise, which shifts AD further to the right. -
4. How big the multiplier effect is will depend on how much consumers respond to increases in income,
- This is calculated by the marginal propensity to consume (MPC):
- the fraction of extra income that households consume rather than savT
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1. What is the marginal propensity to consume (MPC)?
2. Give an example
3. What is the formula for the multiplier?
4. What is the multiplier if MPC is 0.5?
What if its 0.9?
5. What does a bigger MPC mean?
1. The fraction of extra income that households consume rather than save
2. If MPC = 0.8 and income rises $100, C rises $80.
3. Multiplyer = 1/1-MPC
- 4. If MPC = 0.5, multiplier is 2
- If MPC = 0.9, multiplier is 10
- 5. A bigger MPC means changes in Y cause bigger changes in C which in turn cause more changes in Y.
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1. Give an example of how the multiplier could work in reverse?
2. What are 2 reasons that monetary policy is more efficient than fiscal policy in terms of timing?
3. Define crowding out
1. Suppose a recession overseas reduces demand for U.S. net exports by $10b.
Initially, aggregate demand falls by $10b.
The fall in Y causes C to fall, which further reduces aggregate demand and income.
2a.The delays caused by the legislative process can be very long.
b. Even after a change in fiscal policy has been approved, it takes time to implement the policy.
3. Crowding out: A decline in private expenditures as a result of an increase in government purchases.
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1. How does the crowding out effect affect investment (I)?
2. What is the result
3. Visualize how this works on a graph
4. When the gov. increases purchases by $20 billion, will the AD for goods and services rise by more or less than $20 billion?
1. A fiscal expansion shifts AD to the right, but also raises r, which reduces investment and, thus, reduces the net increase in aggregate demand
2. So, the size of the AD shift may be smaller than the initial fiscal expansion.
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4. It depends on whether the multiplier effect or the crowding-out effect is larger.
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1. How do households react when the government cuts personal income tax?
2. What is the effect on the AD curve?
3. What three factors determine the size of the shift in the AD curve?
1. It increases households' take-home pay, and they save some of the extra money, and spend some of it on additional consumer goods.
2. Increased household speding shifts the AD curve to the right
3. The size of the shift is affected by
- a. the multiplier effect
- b. crowding-out effects
- c. Household perceptions about the permanancy of the tax change
* A permanent tax cut causes larger increases in (C) consumption (rather than savings). In other words, if they believe its permanent they will be more willing to upgrade their lifestyle rather than saving the extra money for a rainy day.
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The economy is in recession. Shifting the AD curve rightward by $200b would end the recession.
1. If MPC = 0.8 and there is no crowding out, how much should the government increase G to end the recession?
2. If there is crowding out, will the government need to increase G more or less than this amount?
1. Multiplier = 1/(1 – .8) = 5
Increase G by $40b to shift AD by 5 x $40b = $200b.
2. Crowding out reduces the impact of G on AD.
To offset this, the government should increase G by a larger amount.
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1. Assume that the MPC is 0.75. Assuming only the multiplier effect matters, how will an increase in government purchases of $400 billion shift the aggregate demand curve?
2. Assume that the MPC is 0.8. Assume that there is a multiplier effect and that the total crowding-out effect is $7 billion. How will an increase in government purchases of $8 billion shift aggregate demand?
1. It will shift the aggregate demand curve right by $1600 billion.
2. It will shift aggregate demand right by $33 billion.
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1. While most economists believe that the short-run effects of fiscal policy mainly work through AD, what is an argument that supply-siders use to promote the idea that a tax cut might also affect AS?
2. Give an example of how government purchases could affect AS?
1. A cut in the tax rate gives workers incentive to work more, so it might increase the quantity of g&s supplied and shift AS to the right.
2. Suppose govt increases spending on roads (or other public capital).
Better roads may increase business productivity, which increases the quantity of g&s supplied, shifts AS to the right.
This effect is probably more relevant in the long run, as it takes time to build the new roads and put them into use.
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1. What 2 fluctuations do proponents of active stabilization policy believe the government should be trying to reduce?
2. Who was the most well known of these economists, and what was his argument?
3. What is the argument against active stabilization policy in terms of monetary policy?
4. What is the argument against active stabilization policy in terms of fiscal policy?
5. What do critics of active stabilization policy believe this policy will do to the economy, and what do they propose instead?
1a. When GDP falls below its natural rate, govt. should use expansionary monetary or fiscal policy to prevent or reduce a recession
b. When GDP rises above its natural rate, should use contractionary policy to prevent or reduce an inflationary boom
2. In his book, The General Theory of Employment, Interest and Money, John Maynard Keynes emphasized the key role of aggregate demand in explaining short-run economic fluctuations.
Keynes claimed that the government should actively stimulate aggregate demand when aggregate demand appeared insufficient to maintain production at its full-employment level.
It worked during the Great Depression.
3. Monetary policy affects economy with a long lag:
Firms make investment plans in advance, so I takes time to respond to changes in r
Most economists believe it takes at least 6 months for monetary policy to affect output and employment (They say that the BOC should not try to fine-tune the economy.)
4. Fiscal policy also works with a long lag:
Changes in G and T require legislative bodies.
The legislative process can take months or years.
5. Due to these long lags, critics of active policy argue that such policies may destabilize the economy rather than help it:
By the time the policies affect AD, the economy’s condition may have changed.
These critics contend that policymakers should focus on long-run goals, like economic growth and low inflation instead.
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