Chapter 15: Fiscal Policy © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard,...

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© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 1 of 46

Fiscal policy Changes in federal taxes and purchases that are intended to achieve macroeconomic policy objectives, such as high employment, price stability, and high rates of economic growth.

Fiscal Policy

Automatic stabilizers Government spending and taxes that automatically increase or decrease along with the business cycle.

Automatic Stabilizers versus Discretionary Fiscal Policy

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An Overview of Government Spending and Taxes

The Federal Government’s Share of Total Government Expenditures, 1929–2006

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Federal Purchases and Federal Expenditures as a Percentage of GDP, 1950–2006

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Fiscal Policy


Federal Government Expenditures, 2006

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Fiscal Policy


Federal Government Revenue, 2006

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The Effects of Fiscal Policyon Real GDP and the Price Level

Fiscal Policy

Looks a lot like expansionary and contractionary monetary policy

…except for impacts on interest rates and investment spending

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A Summary of How Fiscal Policy Affects Aggregate Demand

Countercyclical Fiscal Policy

PROBLEM TYPE OF POLICYACTIONS BY CONGRESS AND THE PRESIDENT RESULT

Recession Expansionary Increase government spending or cut taxes

Real GDP and the price level rise.

Rising Inflation

Contractionary Decrease government spending or raise taxes

Real GDP and the price level fall.

The Effects of Fiscal Policyon Real GDP and the Price Level

Don’t Let This Happen to YOU!Don’t Confuse Fiscal Policy and Monetary Policy

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The Government Purchases and Tax Multipliers

FIGURE 15.8

The Multiplier Effect and Aggregate Demand

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Learning Objective 15.3


The Multiplier Effect of an Increase in Government Purchases

This spending multiplier is analogous

but not the same as the deposit multiplier

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A cut in tax rates affects equilibrium real GDP through two channels:

(1) A cut in tax rates increases the disposable income of households, which leads them to increase their consumption spending, and

(2) a cut in tax rates increases the size of the multiplier effect … it reduces the rate at which purchasing power leaks from the spending stream

The less the marginal propensity to leak, the greater the spending multiplier.

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Taking into Account the Effects of Aggregate Supply


The Multiplier Effect and Aggregate Supply

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The Limits of Using Fiscal Policyto Stabilize the Economy

An Expansionary Fiscal Policy Increases Interest Rates

Crowding out A decline in private expenditures as a result of an increase in government purchases.Money market

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The Limits of Using Fiscal Policyto Stabilize the Economy

Crowding Out in the Short Run

FIGURE 15.12

The Effect of Crowding Out in the Short Run

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The Effects of Fiscal Policy in the Long Run

The Economic Effect of “Supply Side” Tax Reform

The Supply-Side Effects of a Tax Change

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Deficits, Surpluses, and Federal Government Debt

The Federal Budget Deficit, 1901–2006

Cyclically adjusted budget deficit or surplus The deficit or surplus in the federal government’s budget if the economy were at potential GDP.

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Did Fiscal Policy Fail during the Great Depression?

Makingthe

Connection

Although government spending increased during the Great Depression, the cyclically adjusted budget was in surplus most years.

FEDERAL GOVERNMENT

EXPENDITURES (BILLIONS OF

DOLLARS

ACTUALFEDERAL BUDGET DEFICIT

OR SURPLUS (BILLIONS OF

DOLLARS)

CYCLICALLY ADJUSTED

BUDGET DEFICIT OR SURPLUS (BILLIONS OF

DOLLARS)

CYCLICALLY ADJUSTED

BUDGET DEFICIT OR SURPLUS AS A PERCENTAGE

OF GDP

1929 $2.6 $1.0 $1.24 1.20%

1930 2.7 0.2 0.81 0.89

1931 4.0 -2.1 -0.41 -0.54

1932 3.0 -1.3 0.50 0.85

1933 3.4 -0.9 1.06 1.88

1934 5.5 -2.2 0.09 0.14

1935 5.6 -1.9 0.54 0.74

1936 7.8 -3.2 0.47 0.56

1937 6.4 0.2 2.55 2.77

1938 7.3 -1.3 2.47 2.87

1939 8.4 -2.1 2.00 2.17

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Deficits, Surpluses, and Federal Government Debt

The Federal Government Debt

The Federal Government Debt, 1901–2006

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K e y T e r m s

Automatic stabilizers

Budget deficit

Budget surplus

Crowding out

Cyclically adjusted budget

deficit or surplus

Fiscal policy

Multiplier effect

Tax wedge

Chapter 15: Fiscal Policy © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard,...

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