Module 7 Fiscal policy

automatic stabilizer

A feature of existing government policy that automatically steadies the economy by decreasing government spending and/or increasing taxes as an economy grows, or by increasing government spending and/or reducing taxes when an economy contracts during a recession automatic stabilizer cause average tax rates to fall, the amount of taxes collected to fall, and the amount of transfer payments to rise, helping to make the recession less severe, even without any direct government action During expansion that exact opposite occurs

progressive tax

A tax for which the percentage of income paid in taxes increases as income increases (and decrease as taxable income decreases)

Aggregate Demand and expenditures

AD = Multiple e * Expenditures

aggregate demand and taxes

AD= multipler t x T

Which is a frequently used tool of fiscal policy?

Changes in government purchases and taxes

contractionary fiscal policy

Fiscal policy used to decrease aggregate demand or supply. Deliberate measures to decrease government expenditures, increase taxes, or both. Appropriate during periods of inflation.

Fiscal policy relies on three assumptions: Recognizing the start of a recession. Government quickly determines effective policy. The policy is immediately effective. Which of these assumptions hold in the real world?

None of the assumptions hold in the real world.

REAL GDP expenditures formula

REAL GDP = Consumption + Gross investment + Government purchases + Net Exports Y= C+I+G+NX Net exports = Exports (X) - Imports (M) NX= X-M

Full employment real GDP

The level of real GDP produced in an economy when it is operating at the natural rate of unemployment also the level of real GDP when the economy is in a long rune equilibrium

Recession

a decline in real output for at least two consecutive quarters

transfer payments

a payment made by the government that does not require an exchange of economic activity in return transfer payment often take the form of payments to households

Expansion

a phase of the business cycle characterized by increasing real GDP, income, and employment

what happens business cycle fluctuations?

cause period of high unemployment, high inflation, and uncertainty

Fiscal policy

changes in government purchases and/or taxes designed to achieve full employment and low inflation sometimes called discretionary fiscal policy or activist fiscal policy

An increase in transfer payments has an effect on the economy similar to:

explicitly increasing government purchases which is the active fiscal policy prescription for a country in recession.

An increase in transfer payments has an effect on the economy similar to

explicitly increasing government purchases, which is the active fiscal policy prescription for a country in recession

If the economy is experiencing a recession, the goal of fiscal policy will be to:

increase aggregate demand The goal of fiscal policy during a recession is to move the economy toward full employment by increasing aggregate demand.

As output rises, income tax collections increase, which tends to dampen aggregate demand and thus help prevent

inflation

Cost push inflation

inflation that occurs due to a decrease in aggregate supply

Demand pull inflation

inflation that occurs due to an increase in aggregate demand activity fiscal policy calls for decreasing government purchases

As incomes rise, people generally pay a:

larger fraction of their income as taxes increasing tax revenues.

loanable funds

money that is available in an economy for the private sector and government to borrow

Government fiscal policy

policy has limitations that reduce its effectiveness and may even cause the opposite of what was intended.

In the short run, in order to stimulate aggregate demand and avoid falling output and prices, the government could

reduce taxes

Taxes

revenues collected by the government form individuals and firms

What is Fiscal policy used for?

smooth out the business cycle, bringing output down when its higher than full employment output and stimulating it when its lower than full employment

expansionary fiscal policy

the application of fiscal policy to increase aggregate demand; involves increasing government purchases and/ or decreasing taxes if the economy is expiring a recession, the government may want to use expansion fiscal policy to help the economy recover more quickly

Multiplier effect

the concept that an additional dollar of expenditures will result in the creation of more than one dollar's worth of real GDP

Expenditures multiple

the effect that a $1 change in expenditure has no real GDP; calculated as the ration of the total change in real GDP due to a change in initial expendute multiplere = y/expendiure = 1/1-MPC =1/MPS

tax multipleir

the effect that a 1 dollar change in taxes has on real GDP; in the aggregate expenditures model calculated as the change in output divided by an initial changes in taxes multiplier t = change in real GDP/ change in Taxes = Y/t = -mpc/1-mpc

Marginal propensity to save (MPS)

the fraction of each additional dollar of income that is saved MPS= Change in savings/ Change in income MPS = S/Y

Marginal Propensity to Consume (MPC)

the fraction of each additional dollar of income that is spent on consumption

interest rate

the payments made to a gents that lend or save money expressed as an annualized percentage of the monetary ammonite lend or saves sometimes called nominal interest rate or price of money

crowing out

the process by which an increase in government borrowing result in less borrowing by business and consumers for private investment

Business cycle

the short term fluctuations experienced in the economy due to changes in levels of economic activty

Implementation lag

the time between when a police is enacted and when it has full effect on the economy

recognition lag

the time between when an event affects an economy and when we recognize that effect in the data collected

legislative lag

the time it takes for policy makers to pass legislation authorizing a new fiscal policy