Understanding Fiscal Policy: Stabilizers, Discretionary Policies, and Economic Impact, Summaries of Macroeconomics

Download Understanding Fiscal Policy: Stabilizers, Discretionary Policies, and Economic Impact and more Summaries Macroeconomics in PDF only on Docsity! Chapter 10 – Fiscal Policy 1 Chapter 10 FISCAL POLICY Macroeconomics in Context, 3rd edition (Goodwin, et al.) Chapter Overview This chapter introduces you to a formal analysis of fiscal policy, and puts it in context with real-world data and examples. The basic analysis you will be presented here follows the Keynesian model, although you will also learn about the “classical” or “supply-side” perspectives. You will gain an understanding of the federal budgets and how it affects the economy. The chapter clarifies the difference between automatic stabilizers and discretionary policy, and discusses recent fiscal policies in terms of their economic impact. Finally, the chapter introduces "crowding out" and "crowding in" and explores the macroeconomic implications of each of these two concepts. Chapter Objectives After reading and reviewing this chapter, you should be able to: 1. Understand the impact of changes in government spending, taxes, and transfers on aggregate expenditure and output. 2. Carry out calculations using “multipliers.” 3. Describe the major types of government outlays, and major government revenue sources. 4. Discuss the issue of lags in fiscal policy, and the relative advantages and disadvantages of automatic and discretionary policies. 5. Distinguish between cyclical deficits and structural deficits. 6. Explain the macroeconomic policy implications of both crowding out and crowding in. Key Terms fiscal policy on-budget expenditures government spending (G) appropriation (of federal funds) transfer payments budget surplus disposable income budget deficit tax multiplier deficit spending balanced budget multiplier countercyclical policy net taxes procyclical policy expansionary fiscal policy automatic stabilizers contractionary fiscal policy cyclical deficit (surplus) government outlays discretionary fiscal policy government bond time lags off-budget expenditures structural deficit (surplus) supply-side economics crowding in crowding out Chapter 10 – Fiscal Policy 2 Active Review Fill in the Blank 1. If the government uses tax cuts to expand the economy, it would be using policy 2. Social security payments that are paid by the government to households are an example of a . 3. Suppose a household receives a wage income of $4,000 a month, and receives $400 in transfers and pays $800 in taxes per month. Then the household’s income (the income after paying taxes and receiving transfers) would be equal to $3,600 per month. 4. To determine the impact on a change in lump sum taxes on equilibrium output, one would use the tax multiplier, which equals . 5. If one were to increase government spending by $50 million, and simultaneously raise taxes by $50 million in order to keep the government budget in balance, one would discover that the multiplier is equal to positive one. 6. Government spending on goods and services (such as new bridges and mass transit) and government transfer payments (such as unemployment compensation and food stamps) are two categories of government . 7. The government can finance its deficits by selling , which are essentially promises to pay back, with interest, the amount borrowed at a specific time in the future. 8. The progressive income tax and transfer payments such as unemployment compensation are examples of , because these tax and spending institutions increase government revenues and lower government outlays during an expansion (and decrease government revenues and raise government outlays during a contraction) thereby smoothing out the business cycle. 9. Suppose the Congress passes a stimulus package, but it takes time for recipients of the stimulus payments to spend the money. The effect may not be seen on the wider economy for a period of time, due to the presence of . 10. The policies that use tax cuts and other incentives in an attempt to increase work, saving and investment, and thereby overall economic output, are called economics. Chapter 10 – Fiscal Policy 5 d. Which fiscal policy--increasing G, decreasing T, or increasing TR--would do the least amount of damage to the government budget deficit? 2. Suppose it was found that the mpc varied by income level in the following manner, with lower income households spending a greater portion of every dollar of income than higher income households. Household income mpc Income/spending multiplier Tax multiplier 0-$30,000 0.9 $31,000 – 50,000 0.8 $51,000 – 80,000 0.75 $80,000 and above 0.6 a. Calculate the government spending and tax multipliers for each income bracket, considered separately. b. Suppose the government decided to use tax cuts to expand the economy, and was debating whether to direct tax cuts to high income households or low income households. Which choice would provide a greater stimulus? Thus, which would do the least amount of damage to the government budget deficit to achieve a given amount of stimulus? (Note: Technically, while tax cuts can, by design of the policy, be targeted so that their initial impact is on the incomes of a particular group, the feedback effects represented by the multiplier probably in general depend on the economy-wide average value of the mpc. We abstract from this issue in this question.) Chapter 10 – Fiscal Policy 6 3. Assume a simple closed economy, with an mpc equal to 0.75. The government has passed a balanced budget amendment. The economy goes into a recession, so the government increases government spending by 40 million to try to expand the economy. a. Calculate the change in output (∆Y) from the increase in government spending (∆G). b. The balanced budget amendment requires the government to also raise taxes by 40 million. Calculate the change in output (∆Y) from the tax hike. c. What is the net effect on output from these two policies? Was there any expansionary effect? d. Why is a balanced budget amendment problematic or undesirable? 4. Use the Figure below to answer the following questions: a. It is sometimes said that Republicans are the party of “small government,” whereas Democrats are the “big spenders” and the party of “big government.” Is this confirmed by the historical evidence of the 1975-2017 period? -12.0 -10.0 -8.0 -6.0 -4.0 -2.0 0.0 2.0 4.0 1 9 7 5 1 9 7 8 1 9 8 1 1 9 8 4 1 9 8 7 1 9 9 0 1 9 9 3 1 9 9 6 1 9 9 9 2 0 0 2 2 0 0 5 2 0 0 8 2 0 1 1 2 0 1 4 2 0 1 7 Federal Surplus or Deficit (as Percent of GDP), 1975 - 2017 Carter Reagan Bush Sr. Clinton Bush Jr. Obama P er ce n t o f G D P Chapter 10 – Fiscal Policy 7 b. What changes in discretionary Government outlays (G, TR) and Tax revenues (T) might explain the emergence of the huge deficits under Reagan, G. Bush Sr., and G.W. Bush Jr? And what might explain the surpluses under Clinton? c. Are changes in discretionary fiscal policy sufficient in explaining the emergence of deficits and surpluses? What role do automatic stabilizers play? Consider in your answer the figure of the U.S. real GDP growth rate, below. d. When Clinton came into office, he increased taxes (the top income bracket was raised somewhat) and cut government spending. These are both considered to be contractionary fiscal policies. And yet the economy boomed. What could explain this? Could the surpluses under his administration come about only from his discretionary fiscal policies? e. The G.W. Bush Jr. administration increased government spending and passed sizeable tax cuts, primarily benefitting the rich. Critics argue that these tax cuts will only lead to deficits and do little to stimulate the economy. Explain their point of view. -4.0 -2.0 0.0 2.0 4.0 6.0 8.0 1 9 7 5 1 9 7 7 1 9 7 9 1 9 8 1 1 9 8 3 1 9 8 5 1 9 8 7 1 9 8 9 1 9 9 1 1 9 9 3 1 9 9 5 1 9 9 7 1 9 9 9 2 0 0 1 2 0 0 3 2 0 0 5 2 0 0 7 2 0 0 9 2 0 1 1 2 0 1 3 2 0 1 5 2 0 1 7 R e al G D P G ro w th ( % ) Chapter 10 – Fiscal Policy 10 c. refers to Federal Reserve policy designed to minimize economic downturns d. refers to Chamber of Commerce efforts to encourage households to shop locally e. none of these are descriptions of procyclical policy 12. During what period of time did the U.S. experience federal government budget surpluses? a. 1980 – 1988 b. 1989 – 1992 c. 1993 – 1997 d. 1998 – 2001 e. 2002 – 2008 13. Which of the following was responsible for putting the budget back into deficit in 2001? a. The recession that started in the Spring of 2001. b. The 2001 Bush tax cuts c. The increased government spending of the Bush administration. d. Both A and B. e. None of the above. 14. The President drafts a budget proposal with new tax cuts and increases in government spending, and has it passed by Congress. This would be an example of: a. Automatic stabilizers b. Discretionary policy c. Contractionary fiscal policy d. Supply side policy e. None of the above. 15. Which of the following is not an example of an inside time lag? a. data lag b. recognition lag c. legislative lag d. transmission lag e. response lag Chapter 10 – Fiscal Policy 11 16. The Obama Stimulus Program ... a. is also known as the "American Recovery and Reinvestment Act." b. added more than three million jobs according to the Congressional Budget Office c. probably averted a 21st century "Great Depression" according to some economists d. amounted to a major expansionary fiscal policy e. all of these statements are accurate 17. The historical evidence of the supply side tax cuts (of the Reagan administration in the 1980s and Bush in the 2000s) is that: a. they were successful in increasing output, increasing tax revenues and lowering deficits. b. they led to lower tax revenues and higher deficits. c. they left output, tax revenues and deficits unchanged. d. while the Reagan tax cuts were successful in increasing tax revenues and lowering deficits, those of the Bush administration were not. e. None of the above. 18. Crowding out refers to ... a. intended investment squeezing unsold inventories b. excess consumer spending competing with foreign demand for U.S. goods c. the demand for exports making U.S. goods for expensive for consumers d. government borrowing reducing the availability of private capital e. none of these 19. Table 10.2 (Different Multiplier Effects) suggests that ... a. making the Bush income tax cuts permanent would have the biggest tax cut impact b. a payroll tax holiday is not a very effective tax cut strategy c. temporarily increasing food stamps is more effective than any permanent tax cut d. cutting the corporate tax rate has a bigger impact than ANY other tax cut e. none of these statements are accurate 20. The A1 appendix for this chapter ... a. focuses on the use of lump-sum taxes b. introduces the importance of the IRS for conducting fiscal policy c. derives the balanced-budget multiplier d. suggests that the multiplier for a change in taxes is larger than for a change in government spending e. none of these statements are accurate Chapter 10 – Fiscal Policy 12 Answers to Active Review Questions 1. fiscal policy 2. transfer payment 3. disposable 4. – (mult)(mpc) 5. balanced budget 6. outlays 7. government bonds 8. automatic stabilizers 9. outside lag 10. supply side 11. False. It is still possible to expand an economy with a balanced budget. The balanced budget multiplier equals 1. 12. False. In the real world the multiplier is rarely this large. Econometric studies of the U.S. economy have suggested the multiplier is 2.0 or lower. 13. True. 14. True. 15. False. The existence of deficits does not necessarily mean an expansionary fiscal policy is being implemented. It could be that the economy is going through a downturn, so the automatic stabilizers are kicking in, with government outlays increasing and tax revenues declining. 16. False. It is: AE = C + II + G + NX 17. The multiplier used in this case is the same as the multiplier introduced in chapter 9: multiplier = 1/(1−mpc) 18. The government could increase government spending, increase transfer payments, or cut taxes. 19. It can either raise taxes, borrow, or print money. 20. The two largest sources of federal revenues are: personal income taxes and social security taxes. The three largest categories of federal outlays are: Social security and Medicare, social programs, and defense spending. 21. The larger the economy, the easier it is to handle a deficit. A larger economy means higher incomes, and a greater ability for the government to collect tax revenues or sell government bonds to finance its deficit. 22. As the economy boomed, the automatic stabilizers kicked in and tax revenues rose. The Clinton administration also used discretionary policy, by raising taxes and thereby raising revenues that helped turn deficits into surpluses. 23. No, tax cuts have also been a component of supply-side policy, which attempts to use tax cuts to stimulate work, saving, investment, and thereby output. Some supply-siders think that the growth in output can actually lead to an increase of tax revenues into the government coffers. 24. The four types of inside lags presented in the chapter include: data lags, recognition lags, legislative lags, and transmission lags. 25. A cyclical deficit is caused by fluctuations in the business cycle while a structural deficit is the result of tax and spending policy decisions. 26. “Crowding out” is a reduction in the availability of private capital resulting from federal