DEBATES IN MACROECONOMICS OVER THE

ROLE AND EFFECTS OF GOVERNMENT

BY: KARYNEL AMORADO

MACROECONOMICS AND GOVERNMENT

TOPICS TAX CUTS, TAX REVENUE, AND BUDGET DEFICIT THE ECONOMY: SELF-REGULATING OR NOT? MORE GOVERNMENT SPENDING OR A CUT IN

TAXES: WHICH GIVES A BIGGER BANG FOR THE BUCK

THE SIZE AND SCOPE OF THE GOVERNMENT THE DEGREE OF CROWDING OUT THE POLITICS OF GOVERNMENT SPENDING MONETARY POLICY: RULES VS DISCRETION BAILOUTS DEMAND-SIDE AND SUPPLY-SIDE VIEW

TAX CUTS, TAX REVENUE AND TAX DEFICIT

TAX CUTTAX REVENUES= TAX BASE X (AVERAGE)

TAX RATE

TAX CUTS, TAX REVENUE AND TAX DEFICIT

ECONOMIST A Tax cuts will raise tax revenue, and

increased tax revenue will decrease the size of the budget deficit.

ECONOMIST B Tax cuts will lower tax revenue, and

decreased tax revenue will increase the size of the budget deficit.

THE ECONOMY: SELF REGULATING OR NOT?

ECONOMIST A Wages are flexible, so that if the economy is in a

recessionary gap, it will soon remove itself from the gap. Government doesn’t have to do anything.

ECONOMIST B Wages are inflexible downward, so that if the

economy is in a recessionary gap, it may be stuck there. The best course of action is for the federal government to implement expansionary fiscal policy or for the Fed to implement expansionary monetary policy to remove the economy from recessionary gap.

MORE GOVERNMENT SPENDING OR A CUT IN A TAXES:

WhenThe economy is in a Recessionary gap and economist call for a demand-side expansionary fiscal policy measure.

MORE GOVERNMENT SPENDING OR A CUT IN A TAXES: ECONOMIST A

The economy needs expansionary fiscal policy to remove it from a recessionary gap. Government should either raise its spending or cut taxes. I believe the government spending multiplier is larger than the tax multiplier, so I suggest government increase its spending.

ECONOMIST B The economy needs expansionary fiscal policy to remove

it from a recessionary gap. Government should either raise its spending or cut taxes. I believe the tax multiplier is larger than the government spending multiplier, so I suggest government cut taxes.

THE SIZE AND SCOPE OF GOVERNMENT

SIZE

SCOPE

THE SIZE AND SCOPE OF GOVERNMENT

ECONOMIST A Expansionary fiscal policy is needed to

raise aggregate demand and remove he economy from recessionary gap. The choice of fiscal policy is between more government spending or a cut in taxes. Since I am in favor of bigger government, I choose more government spending.

ECONOMIST B Since I am in favor of smaller government, I

choose a cut in taxes.

THE DEGREE OF CROWDING OUT

GOVERNMENT SPENDING

THE DEGREE OF CROWDING OUT ECONOMIST A

A rise in government purchase will increase aggregate demand and remove the economy from the recessionary gap because little or no crowding out will occur. A rise in government purchases will end up increasing the number of jobs in the economy.

ECONOMIST B A rise in government purchase will not increase

aggregate demand and remove the economy from the recessionary gap because of complete (or nearly complete) crowding out.

THE POLITICS OF GOVERNMENT SPENDING

ECONOMIST AAn expansionary fiscal policy

measure is needed to increase Real GDP, lower the unemployment rate, and so on. I propose $100 billion more in government spending. It doesn’t matter what the $100 billion is spent on; the important thing is that the money is spent.

THE POLITICS OF GOVERNMENT SPENDING ECONOMIST B

But how the money is spent will be determined by Congress, and Congress is likely to be motivated by political interests. Furthermore, not all spending is the same. Some spending is better for the economy than other spending. I think much of the spending that we will get from Congress will be motivated by politics instead of by economics, and sometimes the spending motivated by politics will be of little help in turning the economy around. In the end, I have my doubts as to how effective increase in government spending will be in aiding economy.

MONETARY POLICY: RULES VS DISCRETION

ECONOMIST A A monetary rule is preferred to a

discretionary Fed. The former is more likely to bring about stable prices, low unemployment, and so on. In addition, a monetary rule removes monetary policy from politics.

ECONOMIST B A discretionary Fed is preferred to a

monetary rule. The Fed needs the flexibility to tailor monetary policy to the existing circumstances.

BAILOUTS

AN ACT OF GIVING FINANCIAL ASSISTANCE TO A FAILING BUSINESS OR ECONOMY TO SAVE IT FROM COLLAPSE.

BAILOUTS ECONOMIST A

Ideally, bailing out companies is not a good idea. But company X is a large company, and if it goes out of business it will adversely affect hundreds of thousands of persons. To save the innocent, you sometimes have to save the not-so-innocent.

ECONOMIST B Who is “we” you say, “We lose more by letting the

company fail than by saving it?”. In the end, this will lead to more companies that “need” to be bailed out.

DEMAND-SIDE AND SUPPLY-SIDE

DEMAND-SIDE AND SUPPLY-SIDE

ECONOMIST A The aggregate supply curve is vertical.

Therefore, government actions designed to change aggregate demand in the economy will not lead to change in Real GDP. Changes in Real GDP come from the supply side of the economy, not the demand side. Government has fewer tools (demand-side fiscal policy and monetary policy won’t work) capable of raising Real GDP than the upward-sloping AS economist believes.

DEMAND-SIDE AND SUPPLY-SIDE VIEWS

ECONOMIST B The aggregate supply curve is upward

sloping (in the short run). Government actions designed to change aggregate demand in the economy will lead to changes in Real GDP (at last in the short run). Changes in Real GDP (in the short run) can come from either the demand side or the supply side of the economy. Government has more tools (demand-side fiscal policy and monetary policy do work) capable of raising GDP than the vertical-AS economist believes.