Macro Chapter 11 & 12
Macroeconomic view
-proper timing of fiscal policy is extremely difficult but also very important - automatic stabilizers help maintain the economy at full employment -fiscal policy is not as powerful (due to the crowding out effects) as early Keynesians may have thought -the Keynesian view and the New Classical view may be correct for different reasons
How does the government borrow money?
By issuing bonds
What is the multiplier effect and what problems are associated with it?
It is a benefit of government spending. A dollar spent by the government to stimulate the economy will lead to more than a dollar being introduced into the economy. Example: The multiplier effect tends to magnify small changes in government spending into larger changes in output and employment Problem: If the people choose to save the money instead of spending it.
What is the Keynesian view of fiscal policy?
Keynes believed that since prices, wages and interest rates were sticky (would not change quickly), the the government needed to step in to boost output during a recession and reduce output during a boom. (Countercyclical fiscal policy)
Budget Surplus
Occurs when the government makes more than it spends during a given year Government Spending < taxes Government Expenditures < Government Revenues
Budget Deficit
Occurs when the government spends more than it makes during a given year Government Spending > taxes Government Expenditures > Government Revenues
What is fiscal policy?
Refers to the GOVERNMENT'S SPENDING, TAXING AND BORROWING POLICIES. **Tool that promotes goals of full employment, price stability, and rapid economic growth.
Paradox of thrift and spending
States that an economy that saves/sends too much may be harmful to growth. Excessive saving will reduce aggregate demand which slows growth. Excessive spending leaves consumers in a very risky position. If an unexpected health issue, hurricane of disaster strikes, they will have no money to pay for it. Example: Politicians will continue to persuade Americans to continue to spend in order to keep the economy moving. Too much spending, though, may cause future issues if Americans are spending everything they earn.
What did Keynesians believe during a recession?
The government should spend more (run a deficit) and/or tax less to stimulate the economy.
Supply of Loanable Funds
comes from savers and lenders -earning interest
Fiscal policy fails to stabilize the economy because budget _______ are more attractive to voters
deficits (because people want to pay less taxes and everyone loves hand outs.. duh)
The crowding out effect states that budget ______ lead to _____ interest rates which ______ private spending.
deficits/higher/reduces
New Classical Econ.
fiscal policy won't shift AD -when the gov't increases spending by running a deficit, people anticipate higher future taxes so they save to pay them -interest rates don't change
Thew argument of debate from the new classical economists
when the government decides to increase spending, taxes are going to rise in the future. This will force consumers to reduce their current spending to pay for the future increases in taxes. So this argument states that Keynesian view is wrong or has little effect on the overall economy.
Keynesians believed that fiscal policy should be used to keep the nation operating at _________.
Full employment (growth rate of 3% and 95% of labor force employed)
Why did Keynesians argue that government spending would be more effect than tax cuts?
G has more affect on Y because of the multiplier affect, tax cut only affect consumption thus less of the multiplier affect
What are the problems of timing when implementing fiscal policy changes?
If we believe in the Keynesian view, we know that the government should increase spending/cut taxes during a recession and decrease spending/increases taxes (leave unchanged) during a boom, but when exactly should they implement the change? We do not know when the recession begins until after it has already started (recognition lag)
Discretionary fiscal policy involves...
issuing bonds, government spending, taxation
The crowding out model implies that *restrictive* fiscal policy will lead to ______ interest rates
lower
What have Bush/Obama done in the past to stimulate the economy?
lower taxes/increase spending
Supply-side economists believe that ____ marginal tax rates will ______ supply and _____ productivity.
lower/increase/increase
During booms people make ________ money and have jobs so taxes _________ and unemployment benefits _________.
more, increase, decrease
Supply side economics
recipe for growth, LOW MARGINAL TAX RATES -encourage productivity b/c if you can keep more of the money you work for there is more motivation to work -discourages purchases of tax deductible items (Lambo) -discourage lobbying/rent seeking
Why is pork barrel legislation usually passed by congress?
benefits are concentrated to a few constituents while costs are spread out over millions of tax payers
Pork Barrel Spending
benefits only a few constituents of a politician while costing all Americans
Demand of Loanable Funds
comes from borrowers -when gov't runs deficit
When the government pursues countercyclical fiscal policy, it will __________ aggregate demand during recessions and __________ aggregate demand during booms. AKA, the government will run a _________ during expansions and a deficit during recession.
increase, decrease, surplus, deficit
Crowding out is the situation where________ government borrowing leads to ______ interest rates which leads to _____ investment by firms.
increased/higher/less
Generally, during booms (economic expansions), tax revenue _____________ and the government spending _____________.
increases, decreases
If the economy was in equilibrium, Keynesians believed that an increase in government spending would lead to...
inflation.
When gov't spending increases by running deficit
interest rates go up -savings become more attractive, borrowing becomes less attractive -private spending (crowding out)
Forcasting
is everything
To finance a budget deficit, the government will...
sell bonds (borrow money)
During booms, Keynesians thought the government should...
spend less and/or tax more (or same amount) since jobs are readily available and income levels are high... the government would apply this *restrictive policy to reduce inflation*
When the economy is operating above full employment, the government should run a budget __________.
surplus... bring in more than they spend
Automatic stabilizers will shift the government budget toward a ________ during expansion and a ______ during a recession.
surplus/deficit
Corporate profit tax/ progressive income tax
when in a boom, taxes will increase and people will spend less which slows down the economy
(supply-side effects of fiscal policy) Argues that lower taxes encourage people to _____, which higher taxes ___________.
work more, discourage people from working
Countercyclical policy would stimulate the economy during ______ times and restrict the economy during _____ times.
bad/good
Argument in support of the government stimulating the economy during a recession.
-Crowding out effect is overstated since the interest rate effect is weak at best. -The Multiplier effect dominates which will increase aggregate demand and get us out of a recession.
Argument agains the government stimulating the economy during a recession.
-Increased government spending will only lead to higher interest rates and higher taxes since politically driven spending is inefficient -Stimulus spending will lead to structural unemployment
Keynes
-countercyclical policy works and should be done -during recession, cut taxes and increase gov't spending due to the the belief that it will shift AD to the right NEEDED to end recession -during booms up taxes down gov't spending this will end inflation
Difference between crowding out and New Classical
-crowding out - interest rates go up - new classical - interest rates stay constant -both believe fiscal policy won't shift AD
Y=
C+I+G+X GDP/OUTPUT
When the economy is operating above full employment, Keynesian's model recommends___________ fiscal policy.
Contractionary (reducing spending and raising taxes)
During a recession, a reduction in taxes will lead to significant growth according to Keynes. Which of the following would dampen the increase in growth?
Crowding out effect
If the government owes $2,500 billion and then borrows $200 billion more this year what is the national debt and deficit?
Debt: 2,700 B, Deficit: 200 B
Government Deficit vs. Debt
Deficit: is YEARLY amount, it's the difference between government spending and taxes. Deficit = Government Spending - Taxes Debt: CUMULATIVE amount, total amount of outstanding government bonds
Why does a tax cut increase aggregate demand?
Disposable income increases and consumption spending increases
What is the crowding out effect?
GOV'T (fiscal policy) CAN'T SHIFT AD when gov't spending increases spending by running deficit, interest rates go up This is a solid argument against the Keynesian view that expansionary fiscal policy works during a recession. Gov't borrows more money to increase spending -> Increase in demand for loanable funds (Bank Loans) -> higher interest rates causing: 1. decrease in investment by firms. 2. decrease in purchases of homes/ cars by consumers increase in investment by foreigners -> appreciation of the dollar -> 3. lower net exports
Balanced Budget
Occurs when government makes as much as it spends Government Spending = taxes Government Expenditures = Government Revenues
How does politics affect fiscal policy changes?
Politicians will be more likely to support lower taxes ad increased government spending. They will be less inclined to support higher taxes and reduced government spending. Therefore, deficits will be more common than surpluses during both expansions and recessions.
Specific areas of government that make fiscal policy decisions...
President and Congress
If the government decides to increase government purchases as we as decrease taxes, then the government is choosing policies designed to counter a ____________.
Recession
What would the government due during restrictive fiscal policy?
Slow economy, increase taxes, decrease gov't spending
True/False: A reduction in the marginal tax rates will tend to increase supply.
True
According to Keynes what happens if there is no government intervention during a recession?
Unemployment increases... Wages decrease... (after some time though, maybe a long time) unemployment will decrease and wages will begin to rise. Keynesians were trying to avoid this prolonged period of unemployment and low wages by stimulating the economy sooner.
Unemployment Compensation
When in a recession unemployment benefits kick in, gets people spending more to get us out of recession
During a recession, Keynes would argue that an increase in taxes used to balance the budget would lead to
a worse recession/depression
The crowding out model and new classical model are both arguments:
against the Keynesian model's view that an increase in government spending will help a nation out of a recession. The potential benefits of an increase in government spending will be offset by higher interest rates and higher taxes
Government purchases increases...
aggregate demand which stimulates the other factors like consumption. This effect is magnified due to the *multiplier effect
Keynesian's stressed that rather than maintain a balanced budget, the government should use ___________ to offset fluctuations in aggregate demand.
countercyclical policy
If the government is running a surplus it will ________ it's debt.
decrease
The crowding out theory states that an expansionary fiscal policy will lead to...
decrease in investment/higher interest rates
If the U.S. was experiencing high unemployment due to weak aggregate demand, then Keynes would recommend a _______ in taxes and NO offsetting _______ in government spending.
decrease/decrease If gov't decreases taxes, then to offset tat decrease in revenues, they would have to spend less.
When the economy is operating at less than full employment, the government should run a budget ______.
deficit (tax less, spend more)
A cut in the tax rate would _____ workers to work _____ which would lead to an ____ in aggregate supply.
encourage/more/increase because... they can keep more of the money that they worked for and have a higher disposable income
Effectiveness Lag
even after legislation is passed, microeconomic effects may not be felt until 6 months later and by that time, the problems may have already cured themselves by the invisible hand
When the economy is operating at less than full employment (recession), Keynesian's model recommends ________ fiscal policy.
expansionary
Primary tools of fiscal policy...
government spending and taxes, basically the "federal budget"
Automatic Stabilizers
help put brakes on the economy when it is booming and gets it going when it is in a downturn with the aid of fiscal policy. Automatic stabilizers help reduce the ups and downs of an economy. Example include: unemployment compensation, corporate tax profit and the progressive income tax
Additional government spending will have a bigger impact on output when the unemployment rate is _____.
high
If the government is running a deficit it will ________ it's debt.
increase
Keynes argued that a tax that increases the budget deficit would ______ aggregate demand and _______ unemployment.
increase, decrease
Increase in speeding by the public sector (government) will decrease purchases in the private sector (firms and consumers) because...
of higher interest rates according to the crowding out model
A major deficiency of using fiscal policy as a stabilization tool is that..
political and economic facts make timing implementation very difficult
Discretionary Fiscal Policy fails to be effective since it is difficult to
time implementation
How does the government implement fiscal policy?
If the government decides to spend money, then it will pay for this spending through taxes or borrowing
Why do we continue to have budget deficits?
It is always easier for politicians to win votes when they implement expansionary fiscal policy during a recession but refuse to implement restrictive fiscal policy during a boom
Who is the economist most responsible for the belief that macro policy designed to balance a budget would contribute to economic instability?
Keynes - believes in countercyclical
Net exports will decline when
x=exports - imports exports down, imports up
What would the government due during expansionary fiscal policy?
boost economy, lower taxes, increase gov't spending
Supply side effects of fiscal policy
changes in *marginal tax rates* have important effects on aggregate supply
A good example of countercyclical fiscal policy would be...
congress authorizing $10 billion in additional spending due to a worsening recession.
Implementation Lag
delays/problems passing legislation (laws) through congress
The crowding out effect refers to the tendency of the additional borrowing accompanying larger budget defects to ______ interest rates and __________ private spending(businesses).
increase/decrease
Fiscal policy will not be effective in stabilizing the economy since politicians find it more attractive to _____ government spending and ____ budget deficits.
increase/increase
Assuming a world where capital flows freely across borders, an increase in interest rates due to a larger budget deficit will
lead to an inflow of foreign capital which will increase U.S. imports
Net exports will increase when
x=imports-exports exports up, imports down
