Eco 200

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Eco 200 Principles of Macroeconomics

• Chapter 12Fiscal Policy

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Fiscal Policy Keynesian region
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Fiscal policy intermediate region
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Fiscal policy classical region
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Multipliers

• Government spending multiplier 1 /
  (MPS MPI)
• Lump-sum tax multiplier
  -(MPC-MPI) / (MPS MPI)
• Balanced-budget multiplier effect of equal
  changes in G and T 1

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Government budget constraint

• Government spending taxes change in
  government debt change in government-issued
  money

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Tax finance of government spending

• Balanced-budget multiplier 1
• Offsetting effects
• Incentive effects may reduce labor supply and
  cause a reduction in AS
• Laffer curve

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Deficit financing of government spending

• Ricardian equivalence
• Individuals may save more in response to higher
  expected future taxes
• Crowding out
• Increased borrowing leads to higher interest
  rates resulting in a reduction in I and C
  (discussed more extensively shortly)

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Monetary expansion used to finance government
spending

• Due to autonomy of Fed, this is less likely to
  occur in the U.S. today.
• If used, tends to be inflationary, resulting in a
  reduction in C.

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Discretionary fiscal policy vs. automatic
stabilizers

• Discretionary fiscal policy changes in
  government spending, taxes, and/or transfer
  payments to achieve a macroeconomic policy goal
• Automatic stabilizers automatic increase in
  transfers and tax reductions as income falls (the
  reverse holds when income rises)
• Examples unemployment compensation, income tax,
  welfare programs.
• Automatic stabilizers reduce the value of the
  multiplier.

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Tax structures

• Proportional tax Tax / income is constant as
  income rises
• Progressive tax Tax / income rises as income
  rises
• Regressive tax Tax / income declines as income
  rises

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Deficits and debt

• Deficit G T amount by which government
  spending exceeds net taxes
• Debt total stock of outstanding government
  bonds
• Deficit a flow variable
• Debt a stock variable

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Deficits, interest rates, and investment

• Loanable funds model

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Demand for loans
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Supply of loans
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Equilibrium
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Increase in deficit
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Costs of deficit

• Crowding out higher interest rates result in
  less investment
• Higher deficit results in currency appreciation
  and a decline in net exports (X)
• Interest payments redistribution of income
• Regressive?
• Foreign debt holdings

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Foreign fiscal policy

• Share of GDP devoted to G is smaller in the U.S.
  than in most developed economies
• Value-added taxes are commonly used in most other
  developed economies