ECN 211 week 14

Federal budget

2 purposes 1. To finance federal government programs and activities 2. To achieve macroeconomic objectives. The first purpose of the federal budget was its only purpose before the Great Depression years of 1930s. The second purpose arose as a reaction to the Great Depression.

Budget deficit Q9

A budget deficit needs government action to decrease it when the deficit is a structural deficit. If the deficit is a structural deficit, then even when the economy is at full employment, the deficit will remain. If the deficit is a cyclical deficit, the deficit will disappear when the economy moves back to full employment. The figure shows that the U.S. federal budget in 2010 is primarily a structural deficit.

Automatic Fiscal Policy example

A fall in GDP that results in a decrease in personal income tax receipts is an example of automatic fiscal policy.

Discretionary Fiscal Policy

A fiscal Policy action initiated by an act of congress is called discretionary fiscal policy.

Automatic Fiscal Policy

A fiscal policy action that is triggered by the state of the economy with no action of government is called automatic fiscal policy. A fall in GDP that results in a decrease in personal income tax receipts is an example of automatic fiscal policy.

The economy is in a recession and the recessionary gap is large

Discretionary fiscal policy is a fiscal action initiated by an act of Congress. When the economy is in a recession, discretionary fiscal policy that will increase aggregate demand and move the economy out of the recession is an increase in government expenditure and a cut in taxes. Automatic fiscal policy is a fiscal action that is triggered by the state of the economy. When the economy is in a recession, needs-tested spending automatically increases and taxes automatically decrease. Because the tax multiplier is less than the government expenditure multiplier, a simultaneous and equal increase in government expenditure and taxes increases aggregate demand and does not bring a budget deficit. Tax revenues and needs-tested spending change automatically in response to the state of the economy. The budget provides automatic stimulus in a recession to help shrink the recessionary gap. When the economy expands, needs-tested spending decreases.

Q3

During 2009 and 2010, transfer payments and government expenditure increased. In particular, transfer payments exploded after 2008 when the government tried to simulate economic activity.

Expansionary fiscal policy

Expansionary fiscal policy when the economy is below full employment increases aggregate demand, increases real GDP, and the price level rises.

Fiscal stimulus

Fiscal Stimulus is the use of fiscal policy to increase production and employment. Spending on domestic infrastructure to drive the economic recovery is fiscal stimulus. A fiscal policy action initiated by an act of congress is called discretionary fiscal policy Spending on domestic infrastructure will require an act of congress, so it is discretionary fiscal policy.

Q5

Fiscal policy does not attempt to achieve a stable money supply.

Freezing taxes

Freezing taxes and cutting government spending decreases aggregate demand. And when aggregate demand decreases, real GDP decreases and the number of jobs decrease. But freezing taxes and cutting government spending also decrease the government budget deficit, which decreases the demand for loanable funds, lowers the real interest rate, and increases investment. The increase in investment increases aggregate demand, which increases real GDP and increases the number of jobs. So we don't know for sure the effect of freezing taxes and cutting government spending on the number of jobs.

Government dept

Government debt is the sum of past budget deficits minus the sum of past budget surpluses. U.S. government dept (as a percentage of GDP) was at an all time high at the end of World War II (World War 2).

Budget balance

The budget balance is equal to receipts minus outlays. Freezing tax rates and cutting federal spending increases the budget balance, or decreases an existing budget deficit. When the government budget deficit decreases, the demand for loanable funds decreases. The real interest rate falls and investment increases.

Q15

The economy is in a recession, so at least some of the deficit is a cyclical deficit. The cyclical deficit arises in part because needs-tested spending increases in a recession and taxes automatically decrease. We don't know whether the economy has a structural surplus or a structural deficit. Because the economy is in a recession, needs-tested spending is increasing and taxes are automatically decreasing, which increases aggregate demand and decreases the output gap. If the government implements an increase in government expenditure, the budget deficit increases both while the economy is in the recession and when the economy returns to full employment. Unless action is taken when the economy reaches full employment, the structural deficit will increase. If the economy has a structural surplus, then the increase in government expenditure will decrease the size of the structural surplus.

Structural deficit Q18

The figure shows an economy that has a structural deficit. When potential GDP is $11 trillion, outlays exceed receipts. Suppose that actual real GDP is $11.5 trillion. When real GDP is $11.5 trillion, the economy still has a deficit, the the deficit is smaller than the structural deficit. So the total deficit is made up of a cyclical surplus- because real GDP is greater than potential GDP- plus the structural deficit. Because the economy is in an expansion, needs-tested spending is decreasing and taxes are increasing, which decreases aggregate demand. If the government implements a decrease in government expenditure, it decreases the budget deficit now and when the economy returns to full employment. The structural deficit will decrease.

Recessionary Gap Q10

The figure shows an economy that is originally at the intersection of the AD0 curve and the SAS curve. There is a recessionary gap. With perfectly executed fiscal stimulus, the economy returns to potential GDP when aggregate demand increases and the aggregate demand curve shifts rightward with a multiplier effect to AD1. The government can increase aggregate demand by implementing discretionary fiscal policy that increases expenditure or cuts taxes.

Q17

The government expenditure multiplier is the quantitative effect of a change in government expenditure on real GDP. The tax multiplier is the quantitative effect of a change in taxes on real GDP. Suppose the government implements a same-sized decrease in taxes and increase in government expenditure. If the tax multiplier exceeds the government expenditure multiplier, real GDP increases. If the government expenditure multiplier exceeds the tax multiplier, real GDP decreases. And if the tax multiplier equals the government expenditure multiplier, real GDP does not change.

Budget Proposal

The president submits a budget proposal to Congress in February 2010. Congress debates, amends, and enacts the budget between February 2010 and October 1, 2010 Fiscal 2011 begins Oct 1, 2010 Between October 1, 2010 and September 30, 2011, supplementary budget laws may be passed. Fiscal 2011 ends on September 30, 2011

buisness cycle lag

The use of discretionary fiscal policy is seriously hampered by 3 time lags: recognition lag, law-making lag, and impact lag. The recognition lag is the time it takes to figure out that fiscal policy actions are needed. The law-making lag is the time it takes congress to pass the laws needed to change taxes or spending. The impact lag is the time it takes from passing a tax or spending change to its effects on real GDP being felt.

GDP

When real GDP increases in a business cycle expansion, wages and profits rise, so tax revenues from these incomes rise. This increase in taxes services as an automatic fiscal policy that slows down the growth of real GDP. When real GDP decreases in a recession, unemployment is high and the number of people experiencing economic hardship increases, so needs-tested spending on unemployment benefit and food stamps increase. The increase in needs-tested spending is an automatic fiscal policy that increases real GDP.

Government froze Q14

When the government cuts taxes in the labor market, the supply of labor increases. Jobs increase. When the government cuts taxes in the capital market, the supply of loanable funds increases. The real interest rate falls and investment increases.

Fiscal Policy

the use of the federal budget to achieve macroeconomic objectives such as full employment, sustained economic growth, and price level stability. Fiscal Policy is made by the President and Congress on an annual timeline.