S08 LEC151

1
Recessionary Gap
2
Fiscal Policy Example

• Suppose simple linear model with only one nonzero
  marginal propensity, mpc.75
• So, KG 4 note this is 1/(1-mpc)
• So, KT -3 note this is -mpc/(1-mpc)
• So, KBB 1 note this is KGKT
• Suppose
• Y 1,300
• YFE 1,400 ? a recessionary gap of 100
• THEN...

3

• Expansionary Fiscal Policy
• Increase G (how much?)
• Decrease T (how much?)
• Increase G Increase T together (how much?)

4
Inflationary Gap
5
The Budget, Budget Deficit and Debt

• The federal budget is the budget of the federal
  government.
• The difference between the federal governments
  receipts and its expenditures is the federal
  surplus () or deficit (-).
• If G exceeds T, the government must borrow from
  the public to finance the deficit.
• It does so by selling Treasury bonds and bills.
  In this case, a part of household saving (S) goes
  to the government.
• The federal debt is the total amount owed by the
  federal government. The debt is the sum of all
  accumulated deficits minus surpluses over time.
• Some of the federal debt is held by the U.S.
  government itself and some by private
  individuals. The privately held federal debt is
  the private (non-government-owned) portion of the
  federal debt.

6
The Federal Budget
7
The Federal Government Surplus () or Deficit
(-) as a Percentage of GDP, 1970 I-2003 II
8
The Federal Government Debt as a Percentage of
GDP, 1970 I-2003 II
9
(No Transcript)
10
(No Transcript)
11
(No Transcript)
12
The Government Budgets Influence on the Economy

• Expansionary Fiscal Policy
• Contractionary Fiscal Policy
• Composition of GDP, Employment, etc.
• Size of the Government
• Pressure on Prices and Interest Rates

13
The Economys Influence on the Government Budget

• Automatic stabilizers are revenue and expenditure
  items in the federal budget that automatically
  change with the state of the economy in such a
  way as to stabilize GDP.
• Fiscal drag is the negative effect on the economy
  that occurs when average tax rates increase
  because taxpayers have moved into higher income
  brackets during an expansion.
• The full-employment budget is what the federal
  budget would be if the economy were producing at
  a full-employment level of output.
• The cyclical deficit is the deficit that occurs
  because of a downturn in the business cycle.
• The structural deficit is the deficit that
  remains at full employment.

14
Where we are and where were going
15
The Money Market

• What is Money
• Supply of Money
• Demand for Money
• How Money enters the model of the determination
  of Y
• How Money affects fiscal and monetary policy

16
The Frugal Governed Open Economy

• AEd C I G EX IM
• Need to specify all the relationships
• C
• I
• G
• EX
• IM
• T

17
Money is What Money Does

• Money is anything that is generally accepted as a
  medium of exchange.
• Money is not income, and money is not wealth.
• Define Money by its functions
• a means of payment/medium of exchange
• a store of value
• a unit of account
• Money brings together savers and borrowers via
  the middle man the lender

18
Why Money?

• Barter is the direct exchange of goods and
  services for other goods and services.
• A barter system requires a double coincidence of
  wants for trade to take place.
• Money eliminates this problem and many others by
  the functions it serves.

19
Moneys Many Functions

• As a medium of exchange, or means of payment,
  money is generally accepted by buyers and sellers
  as payment for goods and services.
• As a store of value, money serves as an asset
  that can be used to transport purchasing power
  from one time period to another.
• As a unit of account, money is a standard that
  provides a consistent way of quoting prices.

20
Money

• Money is easily portable, and easily exchanged
  for goods at all times.
• The liquidity property of money makes money a
  good
• medium of exchange
• as well as a store of value
• and unit of account.

21
Early Coin Money

• A Historical Perspective Coins
• Early coins were tied to the value of the
  precious metals used to make them.
• Got clipping
• Gershams Law - bad money drives out good

22
Early Paper Money

• A Historical Perspective Goldsmiths
• Goldsmiths functioned as warehouses where people
  stored gold for safekeeping.
• A goldsmith would issue a receipt to the
  depositor. Eventually, these receipts themselves
  began to be traded for goods, and were backed
  100 by gold.
• Then, Goldsmiths realized that they could lend
  out some of this gold without any fear of running
  out. Now there were more claims than there were
  ounces of gold on hand. The beginning of a
  fractional reserve system!
• A run on a goldsmith (or a modern-day bank)
  occurs when many people present their claims at
  the same time.

23
Commodity and Fiat Monies

• Commodity monies are items used as money that
  also have intrinsic value in some other use.
  Gold is one form of commodity money.
• Fiat, or token, money is money that is
  intrinsically worthless.
• Legal tender is money that a government has
  required to be accepted in settlement of debts.
• Currency debasement is the decrease in the value
  of money that occurs when its supply is increased
  rapidly.