macroeconomic policy 14 fiscal policy & monetary policy 14-1
TRANSCRIPT
Macroeconomic Policy
14
Fiscal Policy & Monetary policy
14-1
Main points
Economic objectiveDiscretionary Fiscal policy Fiscal Policy InstrumentsThe Crowding Out Effect Automatic stabilizersMultiplier
Economic objective
Full employment
Price stabilization
Economic growth
International payment balance
Stabilization policy
• Stabilization policy describes both monetary and fiscal policy, the goals of which are to smooth out fluctuations in output and employment and to keep prices as stable as possible.
Tax rates are controlled by the government, but tax revenue depends on changes in household income and the size of corporate profits, which the government cannot control.
Discretionary fiscal policy refers to changes in taxes or spending that are the result of deliberate changes in government policy.
Government in the Economy
Fiscal Policy -- the Federal government changing its government position (G , T) in order to stabilize the economy.
Fiscal Policy, by its nature, alters the Federal Budget. This chapter also examines the Federal Budget, what it’s made up of, and when budget deficits can be a problem in the economy.
Fiscal Policy
Fiscal Policy Instruments
Government Revenues
Taxes
Public BondsGovernment Expenditures
Government purchase
Transfer payment
Government Expenditure
Social SecurityLaw and OrderEmergency
ServicesHealthEducationDefenceForeign Aid
EnvironmentAgricultureIndustryTransportRegionsCulture, Media and
Sport
The Federal Budget
Federal Budget (or Budget) = Tax Revenues - Government Expenditure (over a given period).
Federal Budget (or Budget) = Tax Revenues - (Government Purchases of Goods and Services + Transfer Payments + Interest on the National Debt).
Budget Definitions
Budget < 0 -- Budget DeficitBudget > 0 -- Budget SurplusBudget = 0 -- Balanced Budget
Realistic Goal -- Balanced Budget when Y = YF.
The US Federal Budget: 2003 (Billions of Dollars)
Tax Revenues $1877.0Government Expenditure $2241.6Federal Budget -$364.6
Source: Economic Indicators, September 2004.
Breakdown of Tax Revenues
Personal Income Taxes = $775.8Corporate Profits Taxes = $191.4Taxes on Production and Imports (e.g. sales and excise taxes) = $89.4Contributions for Social Insurance = $758.2Other = $62.2
Breakdown of Government ExpenditurePurchases of Goods and Services (G) = $658.6Transfer Payments = $1322.5Interest Payments = $214.1Other = $46.4
Source: Economic Indicators, September 2004.
The Budget: In A Notation
Recall variable definitions: -- T = net taxes = tax revenues - (transfer payments + interest on the national debt) -- G = government purchases of goods and services
The Budget and Budget Position
Budget = T - GBudget Position (or size of deficit)
= G - T
The National Debt
The National Debt -- The total accumulated stock of debt owed by the government to its lenders (holders of government bonds).
Expanded by budget deficitsreduced by budget surpluses.
National Debt -- Realistic Goal
Realistic Goal -- consider the
Debt-Income Ratio =
(National Debt)/(GDP).For the US in 2003 =
($3913.6)/($11004.0) = 0.356. Information Source: Economic Indicators, September
2004.
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).
Automatic Stabilizers
Automatic stabilizers smooth fluctuations in disposable income over the business cycle, thereby boosting aggregate demand during periods of recession and dampening aggregate demand during periods of expansion
Two good examples of automatic stabilizers Progressive income tax Unemployment compensation
Progressive Income TaxThe progressive income tax relieves some
of the inflationary pressures that might otherwise arise when output increases above its potential during an economic expansion
Conversely, when the economy is in a recession, real GDP declines but taxes decline faster, so disposable income does not fall as much as real GDP it cushions declines in disposable income, in consumption, and in aggregate demand
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.
Unemployment Insurance-TR
During an economic expansion, unemployment insurance taxes flow from the income stream into the insurance fund, thereby moderating aggregate demand
During a recession, unemployment payments automatically flow from the insurance fund to those who have become unemployed increasing disposable income and consumption
The Income Tax and the Federal 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.
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.
Specific Types of Fiscal Policy
Change Government Purchases of Goods and Services (G)
-- Expansionary: G -- Contractionary: GChange Transfer Payments (Tr)
-- Expansionary: Tr -- Contractionary: Tr
Tax Policy as Fiscal PolicyChange Marginal Tax Rates (t)
-- Expansionary: t -- Contractionary: t
Change Tax Deductions -- Expansionary: Bigger Deductions
-- Contractionary: Smaller DeductionsChange Indirect Business Taxes (e.g. Sales or Excise
Taxes) -- Expansionary: Lower Taxes -- Contractionary: Raise Taxes
Fiscal Policy in the AD-AS Model
Expansionary 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.
Obstacles to Fiscal Policy Effectiveness
Difficulties 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.
The Crowding Out Effect -- An Adverse “Side Effect”
The Crowding Out Effect -- Expansionary fiscal policy creates an increased demand 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.
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 Decrease in investment to some extent offsets
rise in (G - T).rise in (G - T).
Smaller shift in AD curve than would be
without the crowding out effect.
The Crowding Out Effect – Impeding Economic Growth
Crowding Out Effect loss of Investment (I).Decrease in Investment retards the buildup of the
capital stock and possible implementation of new technology (i.e. Labor Productivity).
Smaller shifts in LAS curve, smaller increases in YF.
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
Distinctive Fiscal Policy Actions in the USWorld 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 Cuts of 2001-02?
The Federal Government Surplus/Deficit as a Percentage of GDP, 1970 I2000 IV
The Federal Government Debt as a Percentage of GDP, 1970 I2000 IV
The percentage began to fall in the mid 1990s.
Fiscal Policy Since 1990
The average tax rate rose sharply under President Clinton and fell sharply under President Bush.
The deficit is a concern when tax rates are falling and spending is rising.
Federal Personal Income Taxes as a Percent of Taxable Income, 1990 I-2003 II
Federal Government Consumption Expenditures as a Percent of GDP, 1990 I-2003 II
Federal Transfer Payments and Grants-in-Aid as a Percent of GDP, 1990 I-2003 II
Federal Interest Payments as aPercent of GDP, 1990 I-2003 II
The Government Spending Multiplier
The government spending multiplier is the ratio of the change in the equilibrium level of output (GDP) to a change in government spending.
government spending multiplier
=1/(1-MPC)
边际消费倾向 MPC=△C/△Y
The Government Spending Multiplier
Finding Equilibrium After a $50 Billion Government Spending Increase(All Figures in Billions of Dollars; G Has Increased From 100 in Table 25.1 to 150 Here)
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)
OUTPUT(INCOM
E)Y
NETTAXE
ST
DISPOSABLE
INCOMEYd Y T
CONSUMPTION
SPENDING(C = 100 + .75 Yd)
SAVINGS
(Yd – C)
PLANNEDINVESTME
NTSPENDING
I
GOVERNMENT
PURCHASESG
PLANNEDAGGREGAT
EEXPENDIT
URE C + I + G
UNPLANNED
INVENTORY
CHANGEY (C + I +
G)
ADJUSTMENT
TODISEQUILIBR
IUM
300 100
200 250 50 100 150 500 200 Output
500 100
400 400 0 100 150 650 150 Output
700 100
600 550 50 100 150 800 100 Output
900 100
800 700 100 100 150 950 50 Output
1,100
100
1,000
850 150 100 150 1,100 0 Equilibrium
1,300
100
1,200
1,000 200 100 150 1,250 + 50 Output
The Tax Multiplier
A tax cut increases disposable income, which is likely to lead to added consumption spending. Income will increase by a multiple of the decrease in taxes.
However, a tax cut has no direct impact on spending. The tax multiplier for a change in taxes is smaller than the multiplier for a change in government spending.
The Tax Multiplier
YM P S
( in itia l in c rease in ag g reg a te ex p en d itu re )
1
Y T M P CM P S
TM P C
M P S
( )
1
T ax m ultipM P C
M P Slier
Appendix B:The government spending and tax multipliers
The government spending and tax multipliers are derived algebraically as follows:Y C I G
C a b Y T ( )
Y Y Td T T 0
I I 0
G G 0
Y a b Y T I G ( )Y a bY bT I G Y bY a bT I G Y b a bT I G( )1
Yb
a bT I G* ( )
1
1multiplier value of autonomous
expenditures
Yb b t
a bT I G
1
1 0( )
Appendix A:The government spending and tax multipliers
The government spending and tax multipliers when taxes are a function of income are derived as follows:
Y C I G C a b Y T ( )
Y Y Td
I I 0
G G 0
T T tY 0
Y a bY bT btY I G 0
Y bY btY a bT I G 0
Y b b t a bT I G( )1 0
multiplier value of autonomous expenditures
The Balanced-Budget Multiplier
The balanced-budget multiplier is the ratio of change in the equilibrium level of output to a change in government spending where the change in government spending is balanced by a change in taxes so as not to create any deficit.
However, a tax cut has no direct impact on spending. The tax multiplier for a change in taxes is smaller than the multiplier for a change in government spending.
Appendix A: The Balanced-Budget Multiplier
If we combine the effects of the government spending multiplier and the tax multiplier, we obtain:
Y
G M P S=
1and
Y
T
M P C
M P S
Taxmultiplier
Multiplier ofgovernmentspending
11
M P S
M P C
M P S
M P S
M P S
• In words, a simultaneous increase in government In words, a simultaneous increase in government spending by $1 and lump-sum taxes by $1 will spending by $1 and lump-sum taxes by $1 will increase equilibrium income by $1.increase equilibrium income by $1.
then:
The Balanced-Budget Multiplier
Finding Equilibrium After a $200 Billion Balanced Budget Increase in G and T(All Figures in Billions of Dollars; G and T Have Increased From 100 in Table 25.1 to 300 Here)
(1) (2) (3) (4) (5) (6) (7) (8) (9)
OUTPUT(INCOM
E)Y
NETTAXES
T
DISPOSABLE
INCOMEYd Y T
CONSUMPTION
SPENDING(C = 100 + .75 Yd)
PLANNEDINVESTME
NTSPENDING
I
GOVERNMENT
PURCHASESG
PLANNEDAGGREGAT
EEXPENDITU
RE C + I + G
UNPLANNED
INVENTORY
CHANGEY (C + I +
G)
ADJUSTMENTTO
DISEQUILIBRIUM
500 300 200 250 100 300 650 150 Output700 300 400 400 100 300 800 100 Output900 300 600 550 100 300 950 50 Output1,10
0300 800 700 100 300 1,100 0 Equilibriu
m
1,300
300 1,000 850 100 300 1,250 + 50 Output
1,500
300 1,200 1,000 100 300 1,400 + 100 Output
Fiscal Policy MultipliersSummary of Fiscal Policy Multipliers
POLICY STIMULUS MULTIPLIER
FINAL IMPACT ON
EQUILIBRIUM Y
Government-spendingmultiplier
Increase or decrease in thelevel of governmentpurchases:
Tax multiplier
Increase or decrease in thelevel of net taxes:
Balanced-budgetmultiplier
Simultaneous balanced-budgetincrease or decrease in thelevel of government purchasesand net taxes:
1
1
M P S
M P C
M P S
GM P S
1
TM P C
M P S
G
The Federal BudgetFederal Government Receipts and Expenditures, 2000 (Billions of Dollars)
AMOUNT
PERCENTAGE
OF TOTALReceipts
Personal taxes 774.4 44.9Corporate taxes 211.9 12.3Indirect business taxes 91.3 5.3Contributions for social insurance 645.9 37.5
Total 1,723.4 100.0Current Expenditures
Consumption 463.8 26.5Transfer payments 795.5 45.4Grants-in-aid to state and local governments 224.2 12.8Net interest payments 230.3 13.1Net subsidies of government enterprises 38.4 2.2
Total 1,752.2 100.0Current Surplus (+) or deficit () (Receipts Current Expenditures)
28.8
Source: U.S. Department of Commerce, Bureau of Economic Analysis.
The Tools of Monetary Policy
Open market operationReserve ratioDiscount rate
Monetary Policy
★ Open market operation
Easy Monetary Policy Buying Securities from commercial
banks Bank gives up securities FED pays bank Bank have increased reserveBuying securities from public Public gives up securities Public deposit notes in the bank Bank have increased reserve
• The Tools of Monetary Policy
The Tools of Monetary Policy
Tight Monetary PolicySelling Securities to
commercial banks FED gives up securities Bank pays for securities Bank have decreased reserveSelling securities to public FED gives up securities Public pays by check from bank Bank have decreased reserve
The Tools of Monetary Policy
Raising The Reserve Ratio Bank must hold more reserve Bank decreasing lending Monetary supply decreasing
Lowering The Reserve Ratio Bank must hold less reserve Bank increasing lending Monetary supply increasing
★ Discount Rate
★ The Reserve Ratio
Easy Monetary Policy
Buying securitiesLowering reserve ratioLowering discount rateTight Monetary PolicySelling securitiesRaising reserve ratioRaising discount rate
The Federal reserve
Assets Securities Loans to commercial bankLiabilities Reserves of the commercial
banks Treasury deposits Federal reserve notes
Time Lags RegardingMonetary and Fiscal Policy
Time lags are delays in the economy’s response to stabilization policies.
Two Possible Time Paths for GDP
Path A is less stable—it varies more over time—than path B. Other things being equal, society prefers path B to path A.
Stabilization: “The Fool in the Shower”
Attempts to stabilize the economy can prove destabilizing because of time lags.
Milton Friedman likened these attempts to a “fool in the shower.” The government is constantly stimulating or contracting the economy at the wrong time.
Stabilization: “The Fool in the Shower”
An expansionary policy that should have begun to take effect at point A does not actually begin to have an impact until point D, when the economy is already on an upswing.
Stabilization: “The Fool in the Shower”
Hence, the policy pushes the economy to points F’ and G’ (instead of F and G). Income varies more widely than it would have if no policy had been implemented.
Recognition Lags
The recognition lag refers to the time it takes for policy makers to recognize the existence of a boom or a slump.
Implementation Lags
The implementation lag is the time it takes to put the desired policy into effect once economists and policy makers recognize that the economy is in a boom or a slump.
The implementation lag for monetary policy is generally much shorter than for fiscal policy.
Response Lags
The response lag is the time it takes for the economy to adjust to the new conditions after a new policy is implemented; the lag that occurs because of the operation of the economy itself.
The delay in the multiplier of government spending occurs because neither individuals nor firms revise their spending plans instantaneously.
Macroeconomic Policy
Sustainable Growth
Consistency
CommitmentClarity
Coordination
Cooperation
Economic Stability
Coordination between Monetary and Fiscal Policy
Questions
What are targets of economic polices?What are the instruments of fiscal policy?How does the automatic stabilizer work?Why the fiscal policy has the crowding out
effect to private investment? What are the multipliers of Government
spending, taxes, balanced budget?