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Fiscalpolicyppt 100129081312 Phpapp02
Fiscalpolicyppt 100129081312 Phpapp02
INTRODUCTION
One major function of the government is to stabilize
the economy (prevent unemployment or inflation) Stabilization can be achieved in part by manipulating the public budget-government spending and tax collections-to increase output and employment or to reduce inflation.
LEGISLATIVE MANDATES
A. In
The Employment Act of 1946, Congress proclaimed the role of government in promoting maximum employment, production, and purchasing power. B. The Act created the CEA (Council of Economic Advisers) to advise the President on economic matters. C. It also created the Joint Economic Committee of Congress to investigate economic problems of national interest.
manipulation of taxes and government spending by Congress to alter real domestic output and employment, control inflation, and stimulate economic growth. Discretionary means the changes are at the option of the Federal government. B. Simplifying assumptions: 1. Assume initial government purchases dont depress or stimulate private spending. 2. Assume fiscal policy affects only the demand, not supply, side of the economy.
FINANCING DEFICITS
The method used to finance deficits or dispose of surpluses influences fiscal policy: A. Financing deficits can be done 2 ways: 1. Borrowing: (crowding out effect) The government competes with private borrowers for funds, and could drive up interest rates; the government may crowd out private borrowing, and this offsets the government expansion. 2. Money Creation: When the Federal Reserve loans directly to the government by buying bonds, the expansionary effect is greater since private investors are not buying bonds. (Monetarists argue that this is monetary, not fiscal, policy that is having the expansionary effect in this situation).
DISPOSING OF SURPLUSES
B. Disposing of surpluses can be done in 2 ways:
1. Debt reduction is good, but may cause interest rates to fall and stimulate spending, which could then be inflationary. 2. Impounding or letting the surplus funds remain idle would have greater anti-inflationary impact. The government holds surplus tax revenues which keeps these funds from being spent.
POLICY OPTIONS: G OR T?
Economists have mixed views about whether to use government spending or tax changes to promote stability, depending on their view of the government: 1. If economists are concerned about unmet social needs or infrastructure, they tend to favor higher government spending during recessions and higher taxes during inflationary times. 2. When economists think that government is too large or inefficient, they tend to favor lower taxes for recessions and lower government spending during inflationary periods.
BUILT-IN STABILITY
Built-in stability arises because net taxes (taxes minus transfers and subsidies) change with GDP. Remember that taxes reduce incomes, and therefore, spending. It is desirable for spending to rise when the economy is slumping and to fall when the economy is becoming inflationary. 1. Taxes automatically rise with GDP because incomes rise and tax revenues fall when GDP falls. 2. Transfers and subsidies rise when GDP falls; when these government payments (welfare, unemployment, etc.) rise, net tax revenues fall along with GDP.
BUILT-IN STABILITY
The size of automatic stability depends on responsiveness of changes in taxes to changes in GDP: The more progressive the tax system, the greater the economys built-in stability. 1. Marginal tax rates on personal income can be changes, such as in 1993, when it was increased from 31% to 39.6% to prevent demand-pull inflation. 2. Automatic stability reduces instability, but does not correct this economic instability.
a. b.
To evaluate the direction of discretionary fiscal policy, adjustments need to be made to the actual budget deficits or surpluses. The standardized budget is a better index than the actual budget in the direction of government fiscal policy because it indicates when the Federal budget deficit or surplus would be if the economy were operating at full employment. In the case of a budget deficit, the standardized budget: Removes the cyclical deficit that is produced by swings in the business cycle, and Reveals the size of the standardized deficit, indicating how expansionary the fiscal policy was that year.
actual deficits. Column 3 indicates expansionary fiscal policy of early 1990s became contractionary in the later years shown. Actual deficits have dissapeared and the US budget had actual surpluses after 1999 until the recent recession of last year.
Government has other goals besides economic stability, and these may conflict with stabilization policy. 1. A political business cycle may destabilize the economy: Election years have been characterized by more expansionary policies regardless of economic conditions. 2. State and local finance policies may offset federal stabilization policies. They are often procyclical, because balanced-budget requirements cause states and local governments to raise taxes in a recession or cut spending, making the recession possibly worse. In an inflationary period, they may increase spending or cut taxes as their budgets head for surplus.
net exports which can shift aggregate demand leftward or rightward. B. The net export effect reduces the effectiveness of fiscal policy by offsetting its effects. For example: 1. Expansionary fiscal policy may increase domestic interest rates, which can cause the dollar to appreciate and exports to decline. 2. Contractionary fiscal policy may reduce domestic interest rates, which would cause the dollar to depreciate, and net exports to increase.