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ModuleEconomic Policy and the Aggregate Demand-Aggregate Supply Model
odelKRUGMAN'S
MACROECONOMICS for AP*
20
Margaret Ray and David Anderson
What you will learnWhat you will learn
in thisin this ModuleModule::
• How the AD-AS model is used to formulate macroeconomic policy
• The rationale for stabilization policy
• Why fiscal policy is an important tool for managing economic fluctuations
• Which policies constitute expansionary fiscal policy and which constitute contractionary fiscal policy
1. 20th century British economist.
2. Economic Consequences of the Peace, General Theory of Employment, Interest and Money
3. Adviser at Versailles peace conference.
4. Ballerina
5. Stock and commodity investor.
Keynes QuizKeynes Quiz
• Self-correction?
• “In the long-run, we all are dead.”
• Stabilization Policy
• Monetary
• Fiscal (budget)
Macroeconomic PolicyMacroeconomic Policy
Fiscal policy in USA developed in the 1930s, was formalized in the 1960s and continues today.
Paul Solomon on Fiscal PolicyPaul Solomon on Fiscal Policy
Policy in the Face of Policy in the Face of Demand ShocksDemand Shocks
• Negative Demand Shocks & Positive Demand Shocks
• Why are they bad?
• Should policymakers counteract?
Responding to Supply Responding to Supply ShocksShocks
• Supply shock
• Policy dilemma
The Government Budget and Total The Government Budget and Total SpendingSpending
• GDP = C + I + G + X - M
• The effect of taxes and transfers
• Effects on Investment
Fiscal ToolsFiscal Tools
• Spending
• Taxes
• Transfers
Expansionary and Expansionary and Contractionary Fiscal PolicyContractionary Fiscal Policy
• Expansionary Fiscal Policy
• increase G
• decrease taxes
• increase transfers
Expansionary and Expansionary and Contractionary Fiscal PolicyContractionary Fiscal Policy
• Contractionary Fiscal Policy
• decrease G
• increase taxes
• decrease transfers
Fiscal Policy PracticeFiscal Policy Practice
• Activity 30 -31
• Left side – even questions
• Right side - odds
How sharp are the fiscal tools?How sharp are the fiscal tools?
1. How are taxes related to GDP?
2. How is spending related to GDP?
3. How much of spending is mandatory
4. vs. discretionary?
5. How easy is it to change taxes ….
6. or spending?
Federal Government RevenueFederal Government Revenue
GDP = $17 trillion, Federal revenue $2.9 trillion
Taxes, Government Purchases of Goods Taxes, Government Purchases of Goods and Services, Transfers, and Borrowingand Services, Transfers, and Borrowing
GDP = $17 trillion, Federal spending $3.8 trillion
Fiscal Policy On AutopilotFiscal Policy On Autopilot
• Automatic Stabilizers
• Recession: taxes down, transfers up
• Inflation: taxes up, transfers same or higher
A Cautionary Note: Lags in Fiscal A Cautionary Note: Lags in Fiscal PolicyPolicy
Time lags
•Recognition lag
•Decision lag
•Implementation lag
•Lags make decision making more difficult
Summary Summary
• Expansionary vs. contractionary
• Three fiscal tools
• Automatic stabilizers
• Limitations on fiscal policy
• Time lags
• Mandatory spending = 60% budget
Exit TicketExit Ticket
• Imagine the economy is slipping back into recession.
• You are on the Council of Economic Advisors (student representative). Write a quick note to the president on the pros and cons of:
• Doing nothing.
• Actively pursuing fiscal policy.
Visualizing the U.S. Budget Visualizing the U.S. Budget
The U.S. Budget - A Visual Perspective - YouTube