Lecture Macroeconomics - Chapter 10: Fiscal policy

FISCAL POLICY
CHAPTER 10

SLIDES PREPARED BY JUDITH SKUCE, GEORGIAN COLLEGE
© 2002 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 10

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In this chapter you will learn
What fiscal policy is and what it is used
for
What discretionary fiscal policy is and its
function
About the economy’s built-in stabilizers
What a cyclically adjusted budget is
The problems, criticisms, and
complications of fiscal policy
© 2002 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 10

2


Chapter 10 Topics
Legislative Mandates
Fiscal Policy & the AD-AS Model
Built-In Stabilization

Evaluating Fiscal Policy
Problems, Criticisms &
Complications

© 2002 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 10

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Legislative Mandates
Great Depression
need for
stabilization role
Unemployment Insurance introduced
during World War II
Governments regularly use fiscal
policy to stabilize the economy

© 2002 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 10

4


Chapter 10 Topics
Legislative Mandates
Fiscal Policy & the AD-AS Model

Built-In Stabilization
Evaluating Fiscal Policy
Problems, Criticisms &
Complications

© 2002 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 10

5


Discretionary Fiscal Policy
Definition:
Deliberate changes of
– government expenditures
– taxes

Dependent upon deliberate
decisions in Parliament
© 2002 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 10

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Discretionary Fiscal Policy
Expansionary Fiscal Policy
Recessionary Gap

Options:
Increase Government Spending
Decrease Taxes
Some Combination of the Two
© 2002 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 10

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Expansionary Fiscal Policy
Figure 10-1
Price level

AS

PL0
AD0

recessionary
gap

GDP0

GDPf

Real GDP (billions)

© 2002 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 10

8


Expansionary Fiscal Policy
Figure 10-1
Price level

AS

PL1
PL0

AD1
AD0
GDP0

GDPf

Real GDP (billions)
© 2002 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 10

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Discretionary Fiscal Policy

Contractionary Fiscal Policy
Inflationary Gap
Options:
Decrease Government Spending
Increase Taxes
Some Combination of the Two
© 2002 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 10

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Contractionary Fiscal Policy

Price level

Figure 10-2

AS

PL3
AD3

inflationary
gap
GDPfGDP3
Real GDP (billions)
© 2002 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 10

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Contractionary Fiscal Policy

Price level

Figure 10-2

AS

PL3
PL2
AD3
AD2
GDPf
Real GDP (billions)

© 2002 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 10

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Policy Options: G or T?
depends on political views about
size of government

© 2002 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 10

13


Chapter 10 Topics
Legislative Mandates
Fiscal Policy & the AD-AS Model
Built-In Stabilization
Evaluating Fiscal Policy
Problems, Criticisms &
Complications

© 2002 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 10

14


Automatic or Built-In Stabilizers
A tax or government expenditure
which automatically:
– increases the deficit during recession
phase
– decreases the surplus during inflation
phase

Government
Government establishes
establishes tax
tax rates,
rates,
but
but does
does not
not set
set total
total taxes
taxes
© 2002 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 10

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Automatic or Built-In Stabilizers
Figure 10-3

G,T

T1

T = Net Taxes

Deficit

G (assumed
constant)

{

GDP1

GDP0

© 2002 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 10

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Automatic or Built-In Stabilizers
Figure 10-3

G,T

T

T2

Surplus

G

GDP0 GDP2
© 2002 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 10

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Automatic or Built-In Stabilizers
the stabilizers will automatically
generate an expansionary budget
deficit when GDP is low
and a contractionary surplus when
GDP is high

© 2002 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 10

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Automatic or Built-In Stabilizers
The built-in stability depends on:
Tax Progressivity
–
–
–

Progressive

Proportional
Regressive

The more progressive the tax system, the
greater the automatic stabilization

© 2002 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 10

19


Chapter 10 Topics
Legislative Mandates
Fiscal Policy & the AD-AS Model
Built-In Stabilization
Evaluating Fiscal Policy
Problems, Criticisms &
Complications

© 2002 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 10

20


Cyclically Adjusted Budget
automatic stabilizers can mask the

direction of discretionary fiscal
policy
the cyclically adjusted budget
shows what the budget balance
would be if the economy were
operating at full employment
© 2002 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 10

21


Cyclically Adjusted Budget
Figure 10-4
T

G, T
500
450

the deficit
G is a
by-product of
the recession

GDP2 GDP1 real GDP
(year 2)
(year 1)

fullemployment
© 2002 McGraw-Hill
Ryerson Ltd.
GDP

the cyclically
adjusted
deficit is zero
in year 1 at
GDP11
it is also zero
in year 2 at
GDP22

Macroeconomics, Chapter 10

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Cyclically Adjusted Budget
G, T
500
475
450
425

Figure 10-4
$25 billion
T1
deficit due to

the
cyclically
expansionary
T2
adjusted deficit is
fiscal policy
zero in year 3
G
taxes are reduced
$50 billion
deficit due to
economy enters a
recession
recession in year 4

GDP4 GDP3 real GDP
(year 4)
(year 3)

fullemployment
© 2002 McGraw-Hill
Ryerson Ltd.
GDP

Macroeconomics, Chapter 10

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Recent Canadian Fiscal Policy

neutral to mildly expansionary in the
early 1990s
contractionary in later years
actual deficits have given way to
actual surpluses

© 2002 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 10

24


Chapter 10 Topics
Legislative Mandates
Fiscal Policy & the AD-AS Model
Built-In Stabilization
Evaluating Fiscal Policy
Problems, Criticisms &
Complications

© 2002 McGraw-Hill Ryerson Ltd.

Macroeconomics, Chapter 10

25