fiscal policy, the budget, and the national debt zfiscal policy -- the federal government changing...
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Fiscal Policy, the Budget, and the National Debt
Fiscal Policy -- the Federal government changing its government position (G - T) in order to stabilize the economy.
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The Federal Budget
Budget = Tax Revenues - Government Expenditure (over a given period)
Budget = Tax Revenues - (Government purchases of goods and services + Transfer Payments + Interest on the National Debt)
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Budget Definitions
Budget < 0 -- Budget DeficitBudget > 0 -- Budget SurplusBudget = 0 -- Balanced Budget
Realistic Goal -- Balanced Budget when Y = YF.
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The Federal Budget: 2000 (Billions of Dollars)
Tax Revenues = $2065.7Government Expenditure = $1813.9Budget = $251.8
Source: Economic Indicators, May 2001
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Breakdown of Tax Revenues
Personal Income Taxes = $1017.7Corporate Profits Taxes = $244.0Indirect Business Taxes = $108.4Contributions for
Social Insurance = $695.6
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Breakdown of Government ExpenditurePurchases of Goods and Services
= $489.2Transfer Payments = $782.4Grants-in-aid to State
and Local Governments = $108.4Net Interest Paid = $259.4Net Subsidies of
Gov’t Enterprises = $38.4
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The Budget: In Our Notation
Recall variable definitions:
-- T = net taxes
= tax revenues
- (transfer payments
+ interest on the
national debt)
-- G = government purchases of
goods and services
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The Budget and The Budget Position
Budget = T - GBudget Position (or size of deficit)
= G - T
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The National Debt
The National Debt -- The total accumulated stock of debt owed by the government to its lenders.
Expanded by deficits, reduced by surpluses
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National Debt -- Realistic Goal
Realistic Goal -- consider the Debt-Income Ratio =
(National Debt)/(GDP).Consumers are allowed a Debt-Income
Ratio maximum of 2.0.For the US in 2000 = ($3410.1)/($9963.1) = 0.342 Conclusion – National Debt in US not a
major concern.
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The Income Tax and Automatic Stabilization
Automatic Stabilization -- due to the income tax system, tax revenues change in directions that help to stabilize the economy, without any change in the tax structure (I.e. fiscal policy)
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The Income Tax as an Automatic Stabilizer
Y* (maybe > YF) Tax Revenues
helps to cool the economy
Y* (maybe < YF) Tax Revenues
helps to stimulate the economy
Note -- all this takes place without any change in the tax structure, as prescribed by fiscal policy.
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The Income Tax and the Budget
Y* Tax Revenues T (T - G)A strong and growing economy
improves the budget.
Y* Tax Revenues T (T - G) A weak economy generates a lower
budget.
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Strategy of Fiscal Policy
Expansionary policies seek to induce more purchasing of goods and services by increasing (G - T) -- i.e. G or T.
Contractionary policies seek to induce less purchasing of goods and services by decreasing (G - T) -- i.e. G or T.
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Specific Types of Fiscal Policy
Change Government Purchases of Goods and Services (G)
-- Expansionary: G -- Contractionary: GChange Transfer Payments (TP)
-- Expansionary: TP -- Contractionary: TP
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Tax Policy as Fiscal Policy
Change Marginal Tax Rate (t) -- Expansionary: t -- Contractionary: t
Change Autonomous Net Taxes (T0) – taxes that don’t depend upon income (e.g. sales taxes). -- Expansionary: T0
-- Contractionary: T0
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Fiscal Policy in the AD-AS ModelExpansionary Fiscal Policy shifts the
AD curve rightward, increases Y* and P*.
Contractionary Fiscal Policy shifts the AD curve leftward, decreases Y* and P*.
Note -- like monetary policy, fiscal policy is justified only from a short-run perspective.
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Obstacles to Fiscal Policy EffectivenessDifficulties in getting the proper
policy passed through Congress and the president.
A tax cut that isn’t used for spending. AD curve does not shift rightward, no change in Y*.
Worries about the Federal Budget within a sluggish economy.
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The Crowding Out Effect -- An Adverse “Side Effect”
The Crowding Out Effect -- Expansionary fiscal policy creates an increased need for more borrowing by the government. This financing increases the demand for financial capital. As a result, long-term interest rates (r*) rise and Investment (I*) decreases.
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The Crowding Out Effect -- Fiscal Policy Effectiveness
Crowding Out Effect -- makes fiscal policy less effective than would be otherwise.
Decrease in investment to some extent offsets rise in (G - T).
Smaller shift in AD curve than would be without the crowding out effect.
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Ways to Avoid the Crowding Out Effect
Bottom line -- get the supply of financial capital to shift rightward at the same time as when expansionary fiscal policy occurs.
-- expansionary monetary policy
-- increased private saving
-- increase in foreign capital
inflows
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A Benefit of Government Debt ReductionConsider the “Crowding Out Effect” in
reverse.Suppose that the government runs a
budget surplus and uses it to reduce the national debt.
Demand for financial capital shifts leftward, r* decreases and I* increases, cushions some of the contraction.
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Distinctive Fiscal Policy Actions in the US
World War IIThe Kennedy-Johnson Tax Cut of
1964The Nixon Tax Increase of 1969The Reagan Economic Recovery and
Tax Act of 1981Clinton Tax Increases of 1993Bush Tax Cut of 2001-02?