Learning Objective 15.1
What we learned in last class:
Expansionary vs. Contractionary monetary policy
Static and dynamic AD-AS model to show effects of
monetary policy
Reduce the length of recessions and Fight inflation
Chapter 15: Fiscal Policy
Why does Wall street care about monetary policy
Can the Fed get the timing right.
PCE
The independence of the Fed.
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Fiscal Policy
Learning Objectives
15.1 Define fiscal policy.
15.2 Explain how fiscal policy affects
aggregate demand and how the
government can use fiscal policy to
stabilize the economy.
15.3 Explain how the government
purchases and tax multipliers work.
15.4 Discuss the difficulties that can arise
in implementing fiscal policy.
The tax laws have become
increasingly complicated. …It is not
surprising that millions of Americans
have given up filling out their own
income tax forms, or have to rely on
software such as Intuit’s TurboTax or
H&R Block’s TaxCut.
15.5 Define federal budget deficit and
federal government debt and explain
how the federal budget can serve as
an automatic stabilizer.
15.6 Discuss the effects of fiscal policy in
the long run.
APPENDIX Apply the multiplier formula.
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Learning Objective 15.1
Fiscal Policy
What Fiscal Policy Is and What It Isn’t
Fiscal policy Changes in federal taxes
and purchases that are intended to achieve
macroeconomic policy objectives, such as
high employment, price stability, and high
rates of economic growth.
Chapter 15: Fiscal Policy
Automatic Stabilizers versus Discretionary Fiscal Policy
Automatic stabilizers Government
spending and taxes that automatically
increase or decrease along with the
business cycle.
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Learning Objective 15.1
Fiscal Policy
An Overview of Government Spending and Taxes
FIGURE 15.1
Chapter 15: Fiscal Policy
The Federal Government’s
Share of Total Government
Expenditures, 1929–2006
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Learning Objective 15.1
Fiscal Policy
An Overview of Government Spending and Taxes
FIGURE 15.2
Chapter 15: Fiscal Policy
Federal Expenditures as a
Percentage of GDP, 1950–2006
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Learning Objective 15.1
Fiscal Policy
An Overview of Government Spending and Taxes
FIGURE 15.3
Chapter 15: Fiscal Policy
Federal Government
Expenditures, 2006
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Learning Objective 15.1
Making
the
Chapter 15: Fiscal Policy
Connection
Is Spending on Social Security
and Medicare a Fiscal Time Bomb?
Will the federal government
be able to keep the promises
made by the Social Security
and Medicare programs?
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Learning Objective 15.1
Fiscal Policy
An Overview of Government Spending and Taxes
FIGURE 15.4
Chapter 15: Fiscal Policy
Federal Government
Revenue, 2006
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Learning Objective 15.2
The Effects of Fiscal Policy
on Real GDP and the Price Level
Expansionary and Contractionary Fiscal Policy: An Initial Look
FIGURE 15.5
Chapter 15: Fiscal Policy
Fiscal Policy
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Learning Objective 15.2
The Effects of Fiscal Policy
on Real GDP and the Price Level
Using Fiscal Policy to Influence Aggregate Demand:
A More Complete Account
FIGURE 15.6
Chapter 15: Fiscal Policy
An Expansionary
Fiscal Policy
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Learning Objective 15.2
The Effects of Fiscal Policy
on Real GDP and the Price Level
Using Fiscal Policy to Influence Aggregate Demand:
A More Complete Account
FIGURE 15.7
Chapter 15: Fiscal Policy
A Contractionary
Fiscal Policy
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Learning Objective 15.2
The Effects of Fiscal Policy
on Real GDP and the Price Level
A Summary of How Fiscal Policy Affects Aggregate Demand
Table 15-1
Chapter 15: Fiscal Policy
Countercyclical Fiscal Policy
ACTIONS BY CONGRESS
AND THE PRESIDENT
RESULT
PROBLEM
TYPE OF POLICY
Recession
Expansionary
Increase government
spending or cut taxes
Real GDP and the price
level rise.
Rising Inflation
Contractionary
Decrease government
spending or raise taxes
Real GDP and the price
level fall.
Don’t Let This Happen to YOU!
Don’t Confuse Fiscal Policy and Monetary Policy
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
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Learning Objective 15.3
The Government Purchases and Tax Multipliers
Chapter 15: Fiscal Policy
Multiplier effect The series of
induced increases in consumption
spending that results from an initial
increase in autonomous expenditures.
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Learning Objective 15.3
The Government Purchases and Tax Multipliers
FIGURE 15.9
Chapter 15: Fiscal Policy
The Multiplier Effect
of an Increase in
Government Purchases
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Learning Objective 15.3
The Government Purchases and Tax Multipliers
The ratio of the change in equilibrium real GDP to
the initial change in government purchases is
known as the government purchases multiplier:
Chapter 15: Fiscal Policy
Government purchases multiplier 
Change in equilibrium real GDP
Change in government purchases
The expression for this tax multiplier is:
Tax multiplier 
Change in equilibrium real GDP
Change in taxes
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Learning Objective 15.3
The Government Purchases and Tax Multipliers
FIGURE 15.8
Chapter 15: Fiscal Policy
The Multiplier Effect
and Aggregate Demand
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Learning Objective 15.3
The Government Purchases and Tax Multipliers
Taking into Account the Effects of Aggregate Supply
FIGURE 15.10
Chapter 15: Fiscal Policy
The Multiplier Effect
and Aggregate Supply
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Learning Objective 15.3
The Government Purchases and Tax Multipliers
The Effect of Changes in Tax Rates
A cut in tax rates affects equilibrium real GDP
through two channels:
Chapter 15: Fiscal Policy
(1) A cut in tax rates increases the disposable
income of households, which leads them to
increase their consumption spending, and
(2) a cut in tax rates increases the size of the
multiplier effect.
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Learning Objective 15.3
The Government Purchases and Tax Multipliers
The Multipliers Work in Both Directions
Chapter 15: Fiscal Policy
Increases in government purchases and cuts in
taxes have a positive multiplier effect on
equilibrium real GDP.
Decreases in government purchases and
increases in taxes also have a multiplier effect
on equilibrium real GDP, only in this case, the
effect is negative.
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Learning Objective 15.3
Solved Problem
15-3
Fiscal Policy Multipliers
Chapter 15: Fiscal Policy
Briefly explain whether you agree or disagree with
the following statement: “Real GDP is currently
$12.2 trillion, and potential real GDP is $12.5
trillion. If Congress and the president would
increase government purchases by $300 billion or
cut taxes by $300 billion, the economy could be
brought to equilibrium at potential GDP.”
Government purchases multiplier 
Change in equilibrium real GDP
Change in government purchases
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Learning Objective 15.1
Chapter 15: Fiscal Policy
What we learned in last class:
Fisical Policy
Definition: Federal vs. State/Local, Macroeconomic
Objectives.
Automatic Stabilizers vs. Discretionary.
An overview of government spending and taxes.
The effects of fiscal policy on real GDP and the price level
Expanstionary and Contractionary
The multiplier effect
How it works.
A change in tax rates will change the size of the
multiplier effect.
The multiplier effect works in both directions
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
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Learning Objective 15.4
The Limits of Using Fiscal Policy
to Stabilize the Economy
Chapter 15: Fiscal Policy
Fiscal policy is harder to get timing right than monetary policy:
The delay caused by legislative process and implementation.
Does Government Spending Reduce Private Spending?
Crowding out A decline in private
expenditures as a result of an
increase in government purchases.
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Learning Objective 15.4
The Limits of Using Fiscal Policy
to Stabilize the Economy
Crowding Out in the Short Run
FIGURE 15.11
Chapter 15: Fiscal Policy
An Expansionary Fiscal Policy
Increases Interest Rates
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Learning Objective 15.4
The Limits of Using Fiscal Policy
to Stabilize the Economy
Crowding Out in the Short Run
FIGURE 15.12
Chapter 15: Fiscal Policy
The Effect of Crowding Out
in the Short Run
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Learning Objective 15.4
The Limits of Using Fiscal Policy
to Stabilize the Economy
Crowding Out in the Long Run
To understand crowding out in the
long run, recall that in the long run,
the economy returns to potential GDP.
Chapter 15: Fiscal Policy
Complete crowding out.
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
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Learning Objective 15.4
Making
the
Chapter 15: Fiscal Policy
Connection
Is Losing Your Job Good
for Your Health?
Recent research shows that,
surprisingly, the health of
people who are temporarily
unemployed may improve.
© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e.
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Learning Objective 15.5
Deficits, Surpluses, and Federal Government Debt
Budget deficit The situation in which
the government’s expenditures are
greater than its tax revenue.
Chapter 15: Fiscal Policy
Budget surplus The situation in
which the government’s expenditures
are less than its tax revenue.
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Learning Objective 15.5
Deficits, Surpluses, and Federal Government Debt
FIGURE 15.13
Chapter 15: Fiscal Policy
The Federal Budget Deficit,
1901–2006
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Learning Objective 15.5
Deficits, Surpluses, and Federal Government Debt
How the Federal Budget Can Serve as an Automatic Stabilizer
Chapter 15: Fiscal Policy
Cyclically adjusted budget deficit or
surplus The deficit or surplus in the
federal government’s budget if the
economy were at potential GDP.
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Learning Objective 15.5
Solved Problem
15-5
The Effect of Economic Fluctuations on the Budget Deficit
Chapter 15: Fiscal Policy
The federal government’s budget deficit
was $207.8 billion in 1983 and $185.4
billion in 1984. A student comments, “The
government must have acted during 1984
to raise taxes or cut spending or both.”
Do you agree? Briefly explain.
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Learning Objective 15.5
Deficits, Surpluses, and Federal Government Debt
Should the Federal Budget Always Be Balanced?
Chapter 15: Fiscal Policy
Although many economists believe that it is
a good idea for the federal government to
have a balanced budget when the economy
is at potential GDP, few economists believe
that the federal government should attempt
to balance its budget every year.
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Learning Objective 15.5
Deficits, Surpluses, and Federal Government Debt
The Federal Government Debt
FIGURE 15.14
Chapter 15: Fiscal Policy
The Federal Government
Debt, 1901–2006
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Learning Objective 15.5
Deficits, Surpluses, and Federal Government Debt
Is Government Debt a Problem?
Chapter 15: Fiscal Policy
Debt can be a problem for a government
for the same reasons that debt can be a
problem for a household or a business.
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Learning Objective 15.6
The Effects of Fiscal Policy in the Long Run
The Long-Run Effects of Tax Policy
Tax wedge The difference between
the pretax and posttax return to an
economic activity.
We can look briefly at the effects on aggregate supply
of cutting each of the following taxes:
Chapter 15: Fiscal Policy
• Individual income tax.
• Corporate income tax.
• Taxes on dividends and capital gains.
Tax Simplification
In addition to the potential gains from cutting individual
taxes, there are also gains from tax simplification.
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Learning Objective 15.6
The Effects of Fiscal Policy in the Long Run
How Large Are Supply-Side Effects?
Chapter 15: Fiscal Policy
Most economists would agree that there are
supply-side effects to reducing taxes:
Decreasing marginal income tax rates will
increase the quantity of labor supplied,
cutting the corporate income tax will
increase investment spending, and so on.
The magnitude of the effects is subject to
considerable debate, however.
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