Chapter 16

Why is the timing of fiscal policy is harder?

- The president and a majority of the members of Congress have to agree on changes in fiscal policy - Even after being approved, it takes time to implement it.

Federal government expenditures

-Purchases -Interest on the national debt - Grants to state and local governments - Transfer payments

The total amount the federal government spends on unemployment insurance decreases during an expansion.

An automatic stabilizer because government spending on unemployment insurance automatically decreases as unemployment declines during an expansion.

supply-side economics

Certain fiscal policy actions that are intended to have long-run effects by expanding the productive capacity of the economy and increasing the rate of economic growth.

Fiscal policy

Changes in federal taxes and purchases that are intended to achieve macroeconomic policy goals

What is meant by "crowding out"?

Crowding out refers to a decline in private expenditures—consumption, investment, and net exports—as a result of an increase in government purchases.

When in inflation...

Decreasing government purchase or increasing taxes -> will decrease aggregate demand

Congress and the president enact a temporary cut in payroll taxes.

Discretionary fiscal policy if the temporary cut in payroll taxes was intended to stimulate spending and increase real GDP.

What are automatic stabilizers?

Government spending and taxes that automatically increase or decrease along with the business cycles.

Who is responsible for fiscal policy?

The congress and the president

Cyclically adjusted budget deficit/surplus

The deficit or surplus in Federal Government's budget if the economy were at potential GDP

Tax wedge

The difference between the pretax and posttax return to an economic activity. The smaller the tax wedge for any economic activity, the more of that economic activity will occur.

Discretionary fiscal policy

The government needs to vote to change spending or taxes.

Define government purchases and tax multipliers

The government purchases multiplier is the ratio of the change in equilibrium real GDP to the change in government purchases. The tax multiplier is the ratio of the change in equilibrium real GDP to the change in taxes.

Induced (indirect) effect

The increase in consumption spending that results ​from the initial autonomous increase in government purchases.

Autonomous (direct) effect

The initial increase in government purchases that is the result of a decision by the government.

Name two examples of automatic stabilizers and explain how they can reduce the severity of a recession.

Unemployment insurance payments, which increase during a recession as more workers become unemployed Income taxes, which decrease during a recession as incomes fall. During expansions unemployment insurance payments decrease and income taxes increase.

In what ways does the federal budget serve as an automatic stabilizer for the economy?

When real GDP falls below potential GDP, households and firms pay less in taxes to the federal government and the federal government makes more transfer payments to the unemployed. These changes in taxes and transfer payments make the decline in income smaller than it would otherwise be, which results in a smaller decline in consumption spending. With aggregate demand not declining by as much as it otherwise would, the decline in real GDP is reduced. When real GDP increases above potential GDP, households and firms pay more in taxes and the federal government makes fewer transfer payments. These changes reduce the increase in income that would otherwise take place, which results in a smaller increase in consumption spending. With aggregate demand not increasing by as much as it otherwise would, the increase in real GDP is reduced. By reducing the size of changes in real GDP, the federal budget serves to stabilize the economy.

Budget deficit

When the government's expenditures are greater than its tax revenue.

Budget surplus

When the government's tax revenue is greater than its expenditures.

Is tax multiplier number negative? Why?

Yes, it is a negative number because the change in taxes and the change in real GDP move in opposite directions.

A decrease in government purchases and a increase in taxes will...

have a negative multiplier effect on equilibrium real GDP

An increase in government purchases and a decrease in taxes will...

have a positive multiplier effect on equilibrium real GDP

Contractionary fiscal policy

real GDP and the price level will decrease

Expansionary fiscal policy

real GDP and the price level will increase

When Fed's budget is in deficit

the federal government's debt grows

When Fed's budget is in surplus

the federal government's debt shrinks

multiplier effect

the series of induced increases in consumption spending that results from an initial increase in autonomous expenditures.

A cut in the tax affects equilibrium real GDP through two channels:

1) as tax rate decreases, consumption spending increases 2) and tax rate decreases, multiplier effect increases

The revenue the federal government collects from the individual income tax declines during a recession.

An automatic stabilizer because income taxes paid automatically decline with the fall in income during a recession. However, if the decline in tax revenue was the result of Congress and the president enacting a cut in income tax rates to stimulate the economy, then this action would be an example of discretionary fiscal policy.

Explain the difference between crowding out in the short run and in the long run.

In the short run, an increase in government purchases results in partial crowding out, but in the long run, a permanent increase in government purchases results in the complete crowding out of an equal amount of private expenditures.

When in recession...

Increasing government purchase or decreasing taxes -> will increase aggregate demand

During a recession, California voters approve additional spending on a statewide high-speed rail system.

Not fiscal policy. This is an infrastructure investment by a state government.

The federal government increases spending on rebuilding the New Jersey shore following a hurricane.

Not part of fiscal policy because the action is not intended to affect the national economy.

The federal government changes the required fuel efficiency for new cars.

Not part of fiscal policy, but is an example of environmental policy.

The Federal Reserve sells Treasury securities.

Not part of fiscal policy, but is instead an example of monetary policy.