Macro Chapter 16

4 types of Automatic stabalizers

1. Progressive income tax rates 2. Taxes on corporate profits 3. Unemployment compensation 4. Welfare programs.

4 Supply side fiscal policy initiatives

1. Research and Development tax credits: tax breaks are given to firms that spend resources to develop new technology. 2. Policies that focus on eduction: subsidies or tax breaks for education expenses are given to create incentives to invest in education. 3. Lower corporate profit tax rates: lower taxes increase the incentives for corporations to undertake activities that generate more profit. 4. Lower marginal income tax rates: Lower income tax rates create incentives for individuals to work harder and produce more, because they get a larger share of their income. *Incentives*

When a person's income rises...

he or she might save some of this new income but might be just as likely to spend part of it, too.

Contractionary Fiscal Policy

occurs when the government decreases spending or increases taxes to slow economic expansion. This is used to reduce AD

Spending multiplier

used to determine the total effect on spending from any initial government expenditures. It tells us the total impact on spending from an initial change of a given amount. The greater the MPC, the greater the spending multiplier.

Two reasons for contractionary fiscal policy

1. Expansionary fiscal policy creates deficits during recession. An increase in taxes or a decrease in spending during an economic expansion can work to reduce the budget deficit and pay off some government debt. 2. The government might want to reduct AD if it believes that the economy is expanding beyond its long-run capabilities.

3 Time Lags

1. Recognition lag 2. Implementation lag 3. Impact lag

Total income tax revenue equation

^income tax revenue = ^tax rate * income

Automatic Stabalizers

are government programs that automatically implement countercyclical fiscal policy in response to economic conditions.

Savings Shifts: New Classical Critique

asserts that increases in government spending and decreases in taxes are largely offset by increases in savings. If savings increases, then consumption falls, and this outcome mitigates the positive effects of government spending.

The spending multiplier implies...

that the tools of fiscal policy are very powerful. Not only can the government change its spending and taxing, but multiplies of this spending then ripple throughout the economy over several periods.

Laffer Curve

tries to illustrate the relationship between tax rates and tax revenue.

3 issues of Fiscal Policy

1. Time Lags 2. Crowding out 3. Savings shifts

2 major pieces of Fiscal Policy during the Great Recession

Economic Stimulus Act: taxes; tax rebate for Americans. American Recovery and reinvestment Act; government spending. Both sought to increase AD.

What does expansionary fiscal policy lead to?

Expansionary fiscal policy inevitably leads to increases in budget deficits and the national debt during economic downturns.

Countercyclical Fiscal Policy

Fiscal policy that seeks to counteract business cycle fluctuations. It consists of using expansionary policy during economic downturns and contractionary policy during economic expansions.

Recognition lag

GDP data are released quarterly, and the final estimate for each quarter is not know until 3 months after the period. Unemployment rate data lag even further behind. Growth is not constant; one bad quarter does not always signal a recession. *These factors make it hard to recognize when expansion or contraction starts*

Time lags

If lags cause the effects of fiscal policy to be delayed, there is a risk that the policy can actually magnify the business cycle.

Implementation lag

In the US, legislation must pass both houses of Congress and receive presidential approval before becoming law. For that reason, fiscal policy takes much longer to implement than monetary policy.

Fiscal Policy

Involves the use of government's budget tools, government spending, and taxes to influence the Macroeconomy.

Marginal propensity to consume

Is the portion of additional income that is spent on consumption. MPC = change in consumption/change in income MPC is always: 0<MPC<1

Impact lag

It takes time for the complete effects of fiscal or monetary policy to materialize. The multiplier makes fiscal policy powerful, but it takes time to ripple through the economy.

Crowding Out

Occurs when private spending falls in response to increases in government spending. When crowding out occurs, AD does not increase as anticipated and the fiscal policy becomes less effective.

Expansionary Fiscal Policy

Occurs when the government increases spending or decreases taxes to stimulate the economy toward expansion. Often occurs during a recession.

Tax rates and tax revenue

Raising income tax rates can increase tax revenue. But it turns out that if you raise them too high, tax revenue declines because the high rates provide negative incentives for production. This means that when tax rates are high, a reduction could actually lead to an increase in tax revenue.

Supply Side fiscal policy

involves the use of government spending and taxes to affect the supply, or production, side of the economy.

Spending Multiplier equation

m(s) = 1/(1-MPC) Sometimes called the Keynesian multiplier or fiscal multiplier.