Econ Test 3 - Inflation, Unemployment, and Discretionary Fiscal Policy
What would examples of discretionary fiscal policy be?
A tax cut adopted to stimulate consumption A tax increase adopted to control inflationary pressures A federal jobs program adopted to stimulate consumption
Short-run contractionary Fiscal Policy would result in what?
Aggregate demand moving to the left
Short-run expansionary Fiscal Policy would result in what?
Aggregate demand moving to the right
Using the aggregate supply - aggregate demand model, the tax cuts of 2001 and 2003 that came in the form of tax rebate checks would cause what curve to do what?
Aggregate demand to shift to the right
What is the purpose of fiscal policy?
Alter the direction of the economy
What is the equation for the GDP gap?
GDP gap = actual GDP - potential GDP
How does inflation affect fixed income receivers?
Hurt because money they are receiving is worth less Nominal income - inflation isn't include, it is inflated Real income - inflation has been accounted for, GDP deflator included
How does inflation affect savers?
Hurts them because money has less purchasing power, not worth as much anymore
What is expansionary fiscal policy?
Increase government spending, decrease taxes Shifts AD to the right During recession
What are the equations for MPC?
K = 1/1-MPC MPS + MPC = 1 MPS - 1 = MPC change in consumption/change in income
What is the multiplier equation?
K = 1/1-mpc
What are the equations for MPS?
MPS = 1 - MPC MPS + MPC = 1 K = 1/MPS
What are discouraged workers?
People who have been looking for a job for a long time but couldn't find one so they stopped Not in labor force
What is contractionary fiscal policy?
Shifts AD to the left Decrease government spending, increase taxes During inflation
How does inflation affect people whose sole source of income is from Social Security benefits?
Social Security is an automatic stabilizer, automatically adjusts with inflation Indifferent - neither hurt nor helped
If you were to use an Aggregate Supply Aggregate Demand diagram to model nondiscretionary and discretionary fiscal policy in reaction to a negative aggregate demand shock, what would you see?
The aggregate demand curve move to the left as a result of the shock and The aggregate demand curve move back toward its pre-shock position as a result of these policies
Official unemployment rate statistics may understate or overstate employment? Why?
Understated - part time workers or job seekers who are trying to get full time jobs but are unable to get it, discrimination
What is happening at full employment?
Unemployment is 5% Inflation is constant Inventories are constant No cyclical unemployment
What are built-in or automatic stabilizers?
Welfare, Social Security, Unemployment Payments, help dampen what's going on in the economy Nondiscretionary - already in place, don't have to do anything with them
What happens when the value of the dollar goes up?
the exchange rate rises, so net exports and GDP go down
What is fiscal policy?
a change in government spending and/or taxes to shift the AD curve to bring the economy back to full employment
What is inflation?
a rise in the general price level OR a decrease in purchasing power of the dollar
What does marginal mean?
additional
Fiscal policy is purposeful movements in ____________ designed to direct an economy.
government spending and taxes
What happens with the fiscal policy during inflation?
government spending decreases, taxes increase
What happens with the fiscal policy during a recession?
government spending increases, taxes decrease
The tax cuts of 2001 and 2003 that came in the form of tax rebate checks are good examples of ____________ __________.
fiscal policy
What does core inflation exclude?
food and heat/energy
What is Okun's law?
for every 1% of unemployment above the natural rate, there is a 2% loss of GDP
What is the natural rate of unemployment equal to?
full employment
what does propensity mean?
general behavior
How do you calculate the unemployment rate?
# of people unemployed/the labor force X 100
What does CPIt-1 equal?
$ value of basket in year t - 1 / $ value of basket in base year X 100
What criteria do you have to meet to be counted as employed or unemployed?
1. apart of the labor force 2. must be 16 years old or older 3. must be non-institutionalized 4. must either be working or be looking for work within the last four weeks
What is U-3 (headline unemployment rate)?
4.1%
Given that the multiplier is 2 and the RGDP gap is 1 trillion, how much does the government have to spend to close the gap?
500,000,000 using delta y = k X spending 1,000,000,000,000 = 2 X g g = 500,000,000
What is the multiplier effect?
A change in a component of total spending leads to a larger change in GDP Snowball effect
What are problems with discretionary fiscal policy?
A delay in recognizing a recession A delay in agreeing on a solution to a recession A delay in getting a particular plan implemented with the money getting into peoples' hands
How does inflation affect the federal government?
Biggest borrowers; benefit from unanticipated inflation Give money back to bond holders
How is the inflation rate calculated?
CPIt - CPIt-1 / CPIt-1 X 100 CPI of year Y: dollar value of the basket of consumer goods in the current year/ dollar value of same basket of goods in the base year Inflation rate of year Y = (CPI in year Y - CPI in Y-1) / CPI in Y-1
Who controls Fiscal Policy?
Congress and the president
Who calculates the natural rate of unemployment?
FED, BEA, NBER
Changes in taxes have to be greater than the change in government spending to achieve the same result. Why?
The multiplier is smaller when changing taxes because of the negative sign in the equation People will save part of the tax cut instead of spending it now Gov spending is more effective than tax cut during a recession bc it's easier to put money back into the market than give money to people who are more likely to save it and not spend it
What would examples of nondiscretionary fiscal policy be?
The operation of the welfare state The existence of the progressive federal income tax
What does the multiplier add together?
autonomous and induced spending
Who does inflation hurt?
banks, lenders, people with fixed income
What is frictional unemployment?
between jobs, first time entrants, recent graduates, not concerning type of unemployment frictionally unemployed are unemployed because of frictions in the economy Ex: the time it takes to find a job upon entering the work force
Who does inflation help?
borrowers
What is investment spending?
business spending on machines and factories
How does non discretionary fiscal policy work?
by having Progressive income tax rates take a portion of increased income thereby dampening periods of growth and Welfare programs reduce spending on people when they have increased incomes thereby dampening periods of economic growth
What is cost-push inflation?
comes from input cost/price self-limited - inflation does not last long in this case Increase in oil prices Shifts supply curve
Unemployment that occurs when there is deficient demand for the goods and services of an economy is called?
cyclical unemployment
The tax cuts of 2001 and 2003 that came in the form of tax rebate checks are good examples of ______ fiscal policy.
discretionary
Replacement of a progressive income tax system with a single income tax rate would be an example of what?
discretionary fiscal policy
The 2003 tax rebate is an example of what?
discretionary fiscal policy
Discretionary Fiscal Policy differs from Nondiscretionary Fiscal Policy in that
discretionary requires timely decisions whereas nondiscretionary is built into the system discretionary often takes years to enact, while nondiscretionary takes effect automatically
What does the BLS hold constant so the basket doesn't change?
entertainment education clothing health care communication hotel rooms ...
What are net exports?
exports - imports
What is multiplying?
fast adding
What is the marginal propensity to consume (mpc)?
how much of our last paycheck do we spend and how much do we save (spend 90%, save 10%)
What is the marginal propensity to consume?
how much we spend or mpc 90% or .9
What are some downfalls of the unemployment rate?
if the labor force decreases, the unemployment rate can go up even though the same number of people are unemployed numerator and denominator can affect unemployment rate states may have different experiences, demographic differences, marginal attachment and discouraged workers
What is induced net export spending a function of?
income because when our income goes up, we buy more goods (some of which are from other countries)
Assume the economy is at full employment and that investment spending declines dramatically. If the goal is to restore full employment, gov fiscal policy should be?
increase gov spending, decrease taxes
What is autonomous spending?
independent spending any other spending that isn't income all government spending is autonomous
How are interest rates related to investment spending?
indirectly related
What goes up or down as income goes up or down?
induced spending
When do we use government spending policy?
infrastructure once the recession is over; has to work unless no one spends any of their income; multiplier is larger; better for recession
Who is not in the labor force?
institutionalized, too young, not looking for a job, retired, stay at home moms
What is autonomous net export spending affected by?
interest rates, taxes, exchange rates, other countries' income, and consumer and business confidence
What kind of relationship is there between investment spending and interest rates and business taxes?
inverse relationship
What is marginal investment demand function?
inverse relationship between investment spending and the interest rate
How are interest rates and taxes related to investment spending and consumer and business confidence?
inversely related
What happens if interest rates go down?
it costs less to borrow money for houses, cars, vacations, new major appliances, so we spend more money
How does an equal decrease in government spending and taxes affect AD curve?
it would shift the AD curve slightly to the left because a decrease in spending will have more of a pull to the left than a decrease in taxes will have to the right multiplier effect is larger for government spending
What happens as interest rates fall?
more projects become profitable so firms will borrow more money (from bank or from savings) and use it to purchase new machines, new vehicles, new additions to the factory
What does mpc equal?
mpc = 1/mps
Is a decrease in the unemployment rate always good?
no
Do lenders like inflation?
no because they are getting paid back with money that has less purchasing power
When do we use taxation policy?
no infrastructure improvement; no guarantee that it will be spent; smaller multiplier; hard to reverse - raising taxes later is not so easily politically; better for inflation
What does the Bureau of Labor Statistics (BLS) report?
official unemployment rate for the previous month on the first Friday of the next month
What happens when another country's GDP goes up?
our net exports go up and so does our GDP
What is the labor force?
people who are willing and able to work includes employed and unemployed
What kind of relationship is there between investment spending and business confidence?
positive relationship
What will be achieved during full employment?
potential GDP
What does CPIt equal?
price of basket in current year / price of basket in base year X 100
What is induced spending?
prompted by something (change in income) spending that depends on our income
What is cyclical unemployment?
refers to workers who are hired or laid off due to business cycle conditions concerning type of unemployment
What is demand-pull inflation?
shifts demand curve Gov spending goes up, anything that shifts AD outward, income goes up are examples of demand-pull inflation
What does consume mean?
spend
What does the multiplier process add up?
spending
What happens during a recession?
tax revenue falls (percentage of income), and government spending increases (people get laid off and they have to pay the unemployment benefits) without explicit action by policymakers
What three factors affect autonomous consumer spending?
taxes, interest rates, our confidence in the future
What does how much you need to spend during a recession depend on?
the size of the multiplier (k)
What happens if consumer confidence goes up?
we feel better about the future, so we spend more now
What happens if taxes go down?
we have more money to spend
What does the natural rate of unemployment depend on?
women in the labor force teenagers government search policies firms' job placement information flow labor mobility cultural
What is structural unemployment?
workers whose job skills or education are no longer useful "skills mismatch" most serious/worst type of unemployment
Are inflation rate and unemployment rate constant?
yes
Do borrowers like inflation?
yes less interest for the lender if the borrower uses the extra money to pay his or her debt early
