FISCAL POLICY

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FISCAL POLICY
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Fiscal Policy

• We will not be using the section starting on pg.
  220 on evaluating fiscal policy.
• Nor will I be using graphs.

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Fiscal Policy

• Government policies on taxation and spending.
• All governments have a fiscal policy.

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Fiscal Policy Paying the Bills

• There are a number of ways governments can obtain
  the funds to pay for their spending.
• Conquer another country
• Print money
• Borrow money (issue bonds)
• Raise taxes

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Fiscal Policy Paying the Bills

• It is no longer acceptable to conquer other
  countries to raise money from them.
• Printing money leads to inflation, which is not
  acceptable either.
• When governments borrow money, they have to repay
  it, with tax revenues.
• Ultimately taxes are the only source of funds.

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FISCAL POLICY CHANGES IN SPENDING AND TAXATION
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Fiscal Policy Changes in Taxation

• Key concept
• Disposable income.
• Defined as your after tax income.

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Fiscal Policy Increase in Taxes

• Increased taxation leads to decreased disposable
  income.
• Decreased disposable income leads to decreased
  consumption.
• Decreased consumption is visible as decreased
  sales.
• Decreased sales leads to increased inventory.

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Fiscal Policy Increase in Taxes

• Increased inventory leads to decreased
  production.
• Decreased production leads to rising
  unemployment.
• Rising unemployment leads to decreased incomes
  and decreased disposable income.

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Fiscal Policy Increase in Taxes

• Increased taxation, CETERIS PARIBUS, can lead to
  a fall in the economy.
• But notice the ceteris paribus assumption!

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Fiscal Policy Decrease in Taxes

• Decreased taxation leads to increased disposable
  income.
• Increased disposable income leads to increased
  consumption.
• Increased consumption is visible as increased
  sales.
• Increased sales leads to decreased inventory.

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Fiscal Policy Decrease in Taxes

• Decreased inventory leads to increased
  production.
• Increased production leads to falling
  unemployment.
• Falling unemployment leads to increased incomes
  and increased disposable income.

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Fiscal Policy Decrease in Taxes

• Decreased taxation, CETERIS PARIBUS, can lead to
  growth in the economy.
• But notice the ceteris paribus assumption!

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Fiscal Policy Increased Government Spending

• Increased government spending leads to increased
  employment as both government and business hire
  more people.
• This leads to increased disposable income.
• Increased disposable income leads to increased
  consumption.

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Fiscal Policy Increased Government Spending

• Increased consumption is visible as increased
  sales.
• Increased sales leads to decreased inventory.
• Decreased inventory leads to increased
  production.
• Increased production leads to falling
  unemployment.

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Fiscal Policy Increased Government Spending

• Increased federal government spending, CETERIS
  PARIBUS, can lead to growth in the economy.
• But notice the ceteris paribus assumption!

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Fiscal Policy Decreased Government Spending

• Decreased government spending leads to decreased
  disposable income.
• Decreased disposable income leads to decreased
  consumption.
• Decreased consumption is visible as decreased
  sales.
• Decreased sales leads to increased inventory.

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Fiscal Policy Decreased Government Spending

• Increased inventory leads to decreased
  production.
• Decreased production leads to rising
  unemployment.
• Rising unemployment leads to decreased incomes
  and decreased disposable income.

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Fiscal Policy Decreased Government Spending

• Decreased government spending, CETERIS PARIBUS,
  can lead to a fall in the economy.
• But notice the ceteris paribus assumption!

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How to Boost the Economy?

• Increase federal government spending.
• Decrease federal government taxation.

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Which technique is better?

• Increases in federal government spending
  immediately lead to a rise in the number of jobs
  and consumption.
• Cutting taxation takes many months to impact the
  economy.

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Automatic Stabilizers

• Certain government programs run automatically.
• They arent voted on by Congress every year.
• They function to help stabilize the economy.

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Full Automatic Stabilizers

• 1. Transfer payments
• - welfare
• - unemployment compensation
• 2. Progressive income taxes

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How Stabilizers Work

• Recession leads to a rising number of unemployed
  people.
• Rising unemployment leads to falling incomes.
• Falling incomes leads to falling sales and then
  falling profits.

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How Stabilizers Work

• With unemployment compensation, when people are
  laid off, their income doesnt fall to zero.
• With at least some income, they can spend.

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How Stabilizers Work

• This slows down the collapse in sales
• The slowdown in the fall of sales also slows down
  the process of rising layoffs.
• Altogether this acts to slow down the fall of the
  economy.

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How Stabilizers Work

• Automatic stabilizers increase during recessions,
  which helps reduce the severity of the downturn.
• Automatic stabilizers decrease during periods of
  economic growth.

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Government Borrowing

• All governments normally borrow money, because
• Revenues dont come in at the same time that they
  need to spend.
• Big projects require a large sum at once, and we
  want the costs spread out.

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Government Borrowing

• Government borrowing, by itself, is not bad.
• It is part of normal government functioning.
• Further, federal government borrowing to reduce
  or end a recession isnt necessarily bad, either.

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Federal Government Borrowing

• What is a problem is continuous, very large scale
  borrowing by the Federal government.

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Problems with Federal Government Borrowing

• Federal Budget Deficit
• Federal government spending is greater than
  federal government revenues.
• Federal Budget Surplus
• Federal government spending is less than federal
  government revenues.

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Problems with Federal Government Borrowing

• There are three main problems with large federal
  budget deficits, and the large amount of
  borrowing necessary to pay for it.
• CROWDING OUT
• WEALTH REDISTRIBUTION
• SQUEEZING OUT OTHER SPENDING

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Crowding Out

• To borrow, the Unites States government issues
  United States Treasury bonds.
• Treasury bonds are promises to repay the face
  value of a bond, plus interest, by a certain
  time. IOUs basically.
• People who buy bonds are lending money to the
  government.

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Crowding Out

• 4. The more people lend to the US government, the
  less they have to lend to others.
• Money follows the law of demand if money
  becomes scarce, its price goes up.
• The price of money is the interest that you pay
  for borrowing money.

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Crowding Out

• 7. If money becomes scarce, interest rates rise.
• 8. What happens to consumption when interest
  rates rise?
• 9. What happens to investment when interest rates
  rise?

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Crowding Out

• People would prefer to lend to the US government,
  which is risk-free money.
• Thus when the government borrows, it crowds out
  other borrowers, and interest rates rise.

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Wealth Redistribution

• Ninety (90) of all bonds are owned by the
  richest 10 of all households.
• The United States government repays the
  principle, plus interest.
• To obtain money for the repayment of these loans,
  the US government raises taxes.

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Wealth Redistribution

• Taxes on the wealthy have been falling,
  especially since 1980.
• Taxes on large corporations have been falling,
  especially since 1980.
• So on whom is the tax burden falling?

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Squeezing Other Programs

• Rising federal government deficits leads to
  rising borrowing by the federal government.
• In turn, this means that more federal revenues
  will be spent repaying the borrowed money, in
  future years.

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Squeezing Other Programs

• Rising interest and repayment of past borrowing
  reduces the amount of federal money for any other
  use.
• This means less money available for other
  government programs health, education, road
  repair or the environment.

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Squeezing Other Programs

• We have the statements of former members of the
  Reagan administration that that is exactly why
  they liked the huge government deficits of the
  1980s.
• There is reason to believe that the Bush
  administration is thinking the same way.