Lecture Issues in economics today - Chapter 11

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When you finish this chapter, you should: Define the key terms of economics and opportunity cost and understand how a production possibilities frontier exemplifies the trade-offs that exist in life, distinguish between increasing and constant opportunity cost and understand why each might happen in the real world, analyze an argument by thinking economically, while recognizing and avoiding logical traps.

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Nội dung Text: Lecture Issues in economics today - Chapter 11

Chapter 11 Fiscal Policy McGrawHill/Irwin © 2002 The McGrawHill Companies, Inc., All Rights Reserved.
Chapter Outline • NONDISCRETIONARY AND DISCRETIONARY FISCAL POLICY • USING FISCAL POLICY TO COUNTERACT “SHOCKS” • EVALUATING FISCAL POLICY McGrawHill/Irwin © 2002 The McGrawHill Companies, Inc., All Rights Reserved.
Fiscal Policy • Fiscal Policy is the purposeful movement in government spending or tax policy designed to direct an economy • Discretionary Fiscal Policy: government spending and tax changes enacted at the time of the problem to alter the economy • Nondiscretionary Fiscal Policy: that set of policies that are built into the system to stabilize the economy McGrawHill/Irwin © 2002 The McGrawHill Companies, Inc., All Rights Reserved.
How Nondiscretionary Fiscal Policy Works • Nondiscretionary fiscal policy consists of policies that are built into the system so that an expansionary or contractionary stimulus can be given automatically. • The welfare state and the progressive income tax serve as the built-in policies. – If the economy is in recession, those who lose their jobs are granted unemployment and welfare benefits and they owe less in taxes. – If the economy is growing at an unsustainable rate, people are making a lot of money and are faced with higher tax rates and there are fewer people eligible for government benefits. McGrawHill/Irwin © 2002 The McGrawHill Companies, Inc., All Rights Reserved.
How Discretionary Fiscal Policy Works • If we are in a recession the fiscal policy to stimulate the economy would consist of – Increases in government spending – Decreases in taxes • If we are in an inflationary period the fiscal policy to contract the economy would consist of – Decreases in government spending – Increases in taxes McGrawHill/Irwin © 2002 The McGrawHill Companies, Inc., All Rights Reserved.
Expansionary Fiscal Policy PI AS PI’ PI* AD’ AD RGDP* RGDP’ RGDP McGrawHill/Irwin © 2002 The McGrawHill Companies, Inc., All Rights Reserved.
Contractionary Fiscal Policy PI AS PI* PI’ AD AD’ RGDP’ RGDP* RGDP McGrawHill/Irwin © 2002 The McGrawHill Companies, Inc., All Rights Reserved.
Shocks • A Shock is any unanticipated economic event. – Aggregate Demand Shock: an unexpected event which causes aggregate demand to increase or decrease, e.g. the Sept 11, 2001 terrorist attacks. – Aggregate Supply Shock: an unexpected event which causes aggregate supply to increase or decrease, e.g. Iraq’s 1990 invasion of Kuwait and threat to Saudi Arabia. McGrawHill/Irwin © 2002 The McGrawHill Companies, Inc., All Rights Reserved.
Nondiscretionary and Discretionary Fiscal Policy Combats a Recession PI AS Shock NDFP PI* AD3 AD1 DFP AD2 RGDP* RGDP McGrawHill/Irwin © 2002 The McGrawHill Companies, Inc., All Rights Reserved.
Nondiscretionary and Discretionary Fiscal Policy Combats an Overheated Economy PI AS Shock NDFP AD2 PI* DFP AD3 AD1 RGDP* RGDP McGrawHill/Irwin © 2002 The McGrawHill Companies, Inc., All Rights Reserved.
Nondiscretionary and Discretionary Fiscal in the Wake of a Negative Aggregate Supply Shock AS2 PI Shock AS1 NDFP DFP PI* AD3 AD2 AD1 RGDP* RGDP McGrawHill/Irwin © 2002 The McGrawHill Companies, Inc., All Rights Reserved.
Nondiscretionary and Discretionary Fiscal in the Wake of a Positive Aggregate Supply Shock PI AS1 Shock AS2 PI* NDFP AD1 AD2 RGDP* RGDP McGrawHill/Irwin © 2002 The McGrawHill Companies, Inc., All Rights Reserved.
Evaluating Nondiscretionary Fiscal Policy • Most economists believe that the built-in stabilizers have had a modestly positive effect on diminishing the severity of modern recessions. McGrawHill/Irwin © 2002 The McGrawHill Companies, Inc., All Rights Reserved.
The Mistiming of Discretionary Fiscal Policy • Recognition Lag: the time it takes to measure the state of the economy • Administrative Lag: the time it takes for Congress to agree on a course of action with the president • Operational Lag: the time it takes for the full impact of a government program or tax change to have its effect on the economy McGrawHill/Irwin © 2002 The McGrawHill Companies, Inc., All Rights Reserved.
Political Problems with Fiscal Policy • Expansionary bias is the problem where politicians are more willing to deal with recessions with tax cuts and spending increases than they are to deal with inflationary pressures with tax increases and spending cuts. • The Political Business Cycle suggests that politically motivated fiscal policy is used for short term gain just prior to elections McGrawHill/Irwin © 2002 The McGrawHill Companies, Inc., All Rights Reserved.
The 25-year Abandonment of Discretionary Fiscal Policy • Between 1975 and 2001 fiscal policy was pretty much abandoned as a mechanism for controlling the economy. • Monetary policy was used to expand or contract prices and GDP. • In 2001, the impending recession motivated tax rebates and the Sept. 11 attacks motivated a variety of tax cut and spending increase ideas in Congress. McGrawHill/Irwin © 2002 The McGrawHill Companies, Inc., All Rights Reserved.