Economics 302 (Sec (Sec.

001) Intermediate Macroeconomic Th Theory and dP Policy li

(Spring 2012)
(corrected 2.7.2012)

Prof. Menzie Chinn

Lecture 5 Wednesday February 6 Wednesday, 6, 2012

Outline
Sources of analysis Current events: Stimulus package (ARRA) B d t implications Budget i li ti of f fi fiscal l policy li Full employment budget balance

Non-partisan p and Partisan Analyses y

The CBO is the Congresss nonpartisan economic/budget i /b d t analytical l ti l arm Other agencies include General A Accountability t bilit Office Offi (GAO) and d Congressional Research Service (CRS) Mirrors Mi th the E Executive ti B Branchs h Offi Office of f Management and Budget (OMB) and Council of Economic Advisers (CEA) in White House Always think about whos who s writing what you read

Did the Stimulus Work Work

What does work work mean? Well interpret work to mean increase aggregate demand, demand output output, employment One has to be careful about over what period i d one talks t lk about b t working ki Uncertainty pervades all these analyses (real world vs. textbook)

Estimates of the Impact of ARRA

Source: CEA, Fifth Quarterly Report on the Economic Impact of ARRA (Nov. 18, 2010) http://www.whitehouse.gov/sites/default/files/cea_5th_arra_report.pdf

How Did They Estimate This Effect?

Use the multiplier model we have learned Figure Fi out t how h much ht tax payments t have h been b reduced, how much transfers have increased Figure Fi out t how h much h government t spending di on goods and services Apply multipliers, multipliers then add up effects effects, compare to GDP Annualize to get growth rates Caveat: Have to account for time dimension (impact takes time)

Quantities (Cumulative) ( )

Source: CEA, Fifth Quarterly Report on the Economic Impact of ARRA (Nov. 18, 2010) http://www.whitehouse.gov/sites/default/files/cea_5th_arra_report.pdf

Apply Multipliers (for 09Q2)

IMPACT MULTIPLIERS (within the quarter) Tax cuts: $28.4 bn 0 AMT relief: $ $7.0 bn 0 Bus. Tax incentives: $10.9 bn 0 State fiscal relief: $28 $28.2 2 bn 0.5 05 Aid to directly impacted: $9.8 bn 1 Govt. investment outlays: $7.4 bn 1 (28.4 0)+(7.20)+(10.90)+(28.20.5)+(9.81)+(7.41) ) ( ) ( ) ( ) ( ) ( ) =( = $31.3 bn

Deflate calculate q/q impact Deflate,

GDP deflator in 2009Q2: 109 109.555 555 110 $31.3 bn/1.10 = 28.57 Ch.2005$ 09Q2 real l GDP SAAR SAAR: 12810.45-28.57=12781.88 12810 45 28 57 12781 88 09Q2 real GDP: 12781.88/4 = 3195.47 Impact 2009Q2: 28.57/3195.47 = 0.00894 Annualize impact: p ( (1.00894) )4 = 1.0362 Impact on growth: (1.0362-1)100%= 3.6 ppts
(q/q, (q q, annualized) )

Comparisons, p , Complications p
Impact of 3 3.6 6 ppts vs. vs CEA 2 2.8 8 ppts. ppts Impact vs. dynamic multipliers In I our math, th we assume everything thi happens with a period In reality, impact is different from cumulative long run In 2009Q3, some of the tax cuts in 2009Q2 will have an impact: p how much?

Budget udge Implications p ca o s o of Fiscal sca Policy o cy

What happens if (lump sum) taxes are increased? Does the budget surplus increase dollarfor-dollar with tax increases? Can the budget balance improve with tax cuts?

A (Lump Sum) Tax Increase

set _ m1 = 0 BuS T G T = t 0 + t1Y BuS = (t 0 + t1Y ) GO 0 BuS = t 0 + t1Y GO Y0 = 0 Y =

Tax Increase (cont (contd) d)

0 (c0 c1t0 + b0 + GO0 + x0 m0 ) = (c0 c1t0 + b0 + GO + x0 m0 ) h here = c1t0 Y = (c1t0 ) BuS = t0 + t1Y GO BuS B S = t0 + t1 ( c1t0 ) BuS BuS = t0 (1 c1t1 ) = (1 c1t1 ) < 1 t0

Balanced Budget g Multiplier p

Suppose one needs to keep budget balanced. Assume A t1 = 0, m1 = 0, = 1 /(1 c1 )

Y0 = [c0 c1 (t0 ) + b0 + GOo + x0 m0 ]

Y = [c0 c1 (t0 ) + b0 + GO + x0 m0 ] Y = [c1 (t0 ) + GO]
==> Y = [ c1GO + GO ]
Y = [1 c1 ]GO

t0 = GO

Y / GO = [1 c1 ] = 1

for balanced budget multiplier

Full Employment p y Budget g Balance

Budget Balance

B S T G BuS T = t0 + t1Y BuS = (t0 + t1Y ) GO0

Full-Employment Budget Balance

BuS n Tn G Tn = t0 + t1Yn BuS n = (t0 + t1Yn ) GO0

Full Employment and Actual BuS

.04 .02 02 .00 -.02 -.04 -.06 -.08 -.10 70 75 80 85 90 95 00 Federal budget balance Cyclically adjusted BuS/GDP BuS/GDP 05 10 Cyclically adjusted BuS to Potential GDP

Source: CBO, The Effects of Automatic Stabilizers on the Federal Budget, April 2011.