FISCAL POLICY. Fiscal Policy We will not be using the section starting on pg. 220 on evaluating...

FISCAL POLICY

Fiscal Policy

• We will not be using the section starting on pg. 220 on evaluating fiscal policy.

• Nor will I be using graphs.

Fiscal Policy

• Government policies on taxation and spending.

• All governments have a fiscal policy.

Fiscal Policy: Paying the Bills

• There are a number of ways governments can obtain the funds to pay for their spending.– Conquer another country– Print money– Borrow money (issue bonds)– Raise taxes

Fiscal Policy: Paying the Bills

• It is no longer acceptable to conquer other countries to raise money from them.

• Printing money leads to inflation, which is not acceptable either.

• When governments borrow money, they have to repay it, with tax revenues.

• Ultimately taxes are the only source of funds.

FISCAL POLICY: CHANGES IN SPENDING

AND TAXATION

Fiscal Policy: Changes in Taxation

• Key concept:

Disposable income.

• Defined as: your after tax income.

Fiscal Policy: Increase in Taxes

1. Increased taxation leads to decreased disposable income.

2. Decreased disposable income leads to decreased consumption.

3. Decreased consumption is visible as decreased sales.

4. Decreased sales leads to increased inventory.


5. Increased inventory leads to decreased production.

6. Decreased production leads to rising unemployment.

7. Rising unemployment leads to decreased incomes and decreased disposable income.


• Increased taxation, CETERIS PARIBUS, can lead to a fall in the economy.

• But notice the ceteris paribus assumption!

Fiscal Policy: Decrease in Taxes

1. Decreased taxation leads to increased disposable income.

2. Increased disposable income leads to increased consumption.

3. Increased consumption is visible as increased sales.

4. Increased sales leads to decreased inventory.


5. Decreased inventory leads to increased production.

6. Increased production leads to falling unemployment.

7. Falling unemployment leads to increased incomes and increased disposable income.


• Decreased taxation, CETERIS PARIBUS, can lead to growth in the economy.


Fiscal Policy: Increased Government Spending

1. Increased government spending leads to increased employment as both government and business hire more people.

2. This leads to increased disposable income.

3. Increased disposable income leads to increased consumption.


5. Increased consumption is visible as increased sales.

5. Increased sales leads to decreased inventory.

6. Decreased inventory leads to increased production.

7. Increased production leads to falling unemployment.


• Increased federal government spending, CETERIS PARIBUS, can lead to growth in the economy.


Fiscal Policy: Decreased Government Spending

1. Decreased government spending leads to decreased disposable income.

2. Decreased disposable income leads to decreased consumption.

3. Decreased consumption is visible as decreased sales.

4. Decreased sales leads to increased inventory.


5. Increased inventory leads to decreased production.

6. Decreased production leads to rising unemployment.

7. Rising unemployment leads to decreased incomes and decreased disposable income.


• Decreased government spending, CETERIS PARIBUS, can lead to a fall in the economy.


How to Boost the Economy?

• Increase federal government spending.

• Decrease federal government taxation.

Which technique is better?

• Increases in federal government spending immediately lead to a rise in the number of jobs and consumption.

• Cutting taxation takes many months to impact the economy.

Automatic Stabilizers

• Certain government programs run automatically.

• They aren’t voted on by Congress every year.

• They function to help stabilize the economy.

Full Automatic Stabilizers

1. Transfer payments

- welfare

- unemployment compensation

2. Progressive income taxes

How Stabilizers Work

1. Recession leads to a rising number of unemployed people.

2. Rising unemployment leads to falling incomes.

3. Falling incomes leads to falling sales and then falling profits.


1. With unemployment compensation, when people are laid off, their income doesn’t fall to zero.

2. With at least some income, they can spend.


1. This slows down the collapse in sales

2. The slowdown in the fall of sales also slows down the process of rising layoffs.

3. Altogether this acts to slow down the fall of the economy.


• Automatic stabilizers increase during recessions, which helps reduce the severity of the downturn.

• Automatic stabilizers decrease during periods of economic growth.

Government Borrowing

• All governments normally borrow money, because:

1. Revenues don’t come in at the same time that they need to spend.

2. Big projects require a large sum at once, and we want the costs spread out.

Government Borrowing

• Government borrowing, by itself, is not bad.

• It is part of normal government functioning.

• Further, federal government borrowing to reduce or end a recession isn’t necessarily bad, either.

Federal Government Borrowing

• What is a problem is continuous, very large scale borrowing by the Federal government.

Problems with Federal Government Borrowing

• Federal Budget Deficit– Federal government spending is greater than

federal government revenues.

• Federal Budget Surplus– Federal government spending is less than

federal government revenues.

Problems with Federal Government Borrowing

• There are three main problems with large federal budget deficits, and the large amount of borrowing necessary to pay for it.

1. CROWDING OUT2. WEALTH REDISTRIBUTION3. SQUEEZING OUT OTHER SPENDING

Crowding Out

1. To borrow, the Unites States government issues United States Treasury bonds.

2. Treasury bonds are promises to repay the face value of a bond, plus interest, by a certain time. IOU’s basically.

3. People who buy bonds are lending money to the government.

Crowding Out

4. The more people lend to the US government, the less they have to lend to others.

5. Money follows the law of demand: if money becomes scarce, its price goes up.

6. The price of money is the interest that you pay for borrowing money.

Crowding Out

7. If money becomes scarce, interest rates rise.

8. What happens to consumption when interest rates rise?

9. What happens to investment when interest rates rise?

Crowding Out

10. People would prefer to lend to the US government, which is risk-free money.

11. Thus when the government borrows, it crowds out other borrowers, and interest rates rise.

Wealth Redistribution

1. Ninety (90%) of all bonds are owned by the richest 10% of all households.

2. The United States government repays the principle, plus interest.

3. To obtain money for the repayment of these loans, the US government raises taxes.

Wealth Redistribution

4. Taxes on the wealthy have been falling, especially since 1980.

5. Taxes on large corporations have been falling, especially since 1980.

6. So on whom is the tax burden falling?

Squeezing Other Programs

1. Rising federal government deficits leads to rising borrowing by the federal government.

2. In turn, this means that more federal revenues will be spent repaying the borrowed money, in future years.


1. Rising interest and repayment of past borrowing reduces the amount of federal money for any other use.

2. This means less money available for other government programs: health, education, road repair or the environment.


1. We have the statements of former members of the Reagan administration that that is exactly why they liked the huge government deficits of the 1980’s.

2. There is reason to believe that the Bush administration is thinking the same way.

FISCAL POLICY. Fiscal Policy We will not be using the section starting on pg. 220 on evaluating...

Documents

Transcript of FISCAL POLICY. Fiscal Policy We will not be using the section starting on pg. 220 on evaluating...