Legislative Mandate
Fiscal Policy and the
AD-AS Model
Expansionary and
Contractionary Fiscal
Policy
Financing of Deficits
and Disposing of
Surpluses
Built-In Stability
Evaluating Fiscal Policy
Problems, Criticisms,
and Complications
Fiscal Policy in the
Open Economy
Forecasting the Future
12
C HAPTE R
FISCAL
POLICY
Key Terms
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Copyright McGraw-Hill/Irwin, 2005
LEGISLATIVE MANDATES
Legislative Mandate
Fiscal Policy and the
AD-AS Model
Expansionary and
Contractionary Fiscal
Policy
Financing of Deficits
and Disposing of
Surpluses
Employment Act of 1946
Council of Economic
Built-In Stability
Evaluating Fiscal Policy
Problems, Criticisms,
and Complications
Advisors (CEA)
Fiscal Policy in the
Open Economy
Forecasting the Future
Key Terms
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End
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Joint Economic
Committee (JEC)
Copyright McGraw-Hill/Irwin, 2005
FISCAL POLICY AND THE AD-AS MODEL
Legislative Mandate
Fiscal Policy and the
AD-AS Model
Expansionary and
Contractionary Fiscal
Policy
Financing of Deficits
and Disposing of
Surpluses
Built-In Stability
Evaluating Fiscal Policy
Problems, Criticisms,
and Complications
Fiscal Policy in the
Open Economy
Forecasting the Future
Key Terms
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Two Options
• Discretionary Fiscal Policy
• Non-Discretionary Fiscal
Policy
Expansionary Fiscal Policy
To Reduce Unemployment…
• Increase Government
Spending
• Tax Reductions
• Combinations of the Two
Copyright McGraw-Hill/Irwin, 2005
EXPANSIONARY FISCAL POLICY
the multiplier at work...
Legislative Mandate
$5 billion initial
increase in spending
Fiscal Policy and the
AD-AS Model
Expansionary and
Contractionary Fiscal
Policy
Built-In Stability
Evaluating Fiscal Policy
Problems, Criticisms,
and Complications
Fiscal Policy in the
Open Economy
Price level
Financing of Deficits
and Disposing of
Surpluses
AS
Full $20 billion
increase in
aggregate
demand
P1
Forecasting the Future
Key Terms
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AD2
$490
AD1
$510
Real GDP (billions)
Copyright McGraw-Hill/Irwin, 2005
FISCAL POLICY AND THE AD-AS MODEL
Legislative Mandate
Fiscal Policy and the
AD-AS Model
Expansionary and
Contractionary Fiscal
Policy
Financing of Deficits
and Disposing of
Surpluses
Built-In Stability
Evaluating Fiscal Policy
Problems, Criticisms,
and Complications
Fiscal Policy in the
Open Economy
Forecasting the Future
Key Terms
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End
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Contractionary Fiscal Policy
To Reduce Inflation…
• Decrease Government
Spending
• Tax Increases
• Combinations of the
Two
Copyright McGraw-Hill/Irwin, 2005
CONTRACTIONARY FISCAL POLICY
the multiplier at work...
Legislative Mandate
$5 billion initial
decrease in spending
Fiscal Policy and the
AD-AS Model
Expansionary and
Contractionary Fiscal
Policy
Built-In Stability
Evaluating Fiscal Policy
Problems, Criticisms,
and Complications
Fiscal Policy in the
Open Economy
Price level
Financing of Deficits
and Disposing of
Surpluses
AS
P2
Full $20 billion
decrease in
aggregate
demand
P1
Forecasting the Future
Key Terms
AD3
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AD4
$510 $522
Real GDP (billions)
Copyright McGraw-Hill/Irwin, 2005
Legislative Mandate
Fiscal Policy and the
AD-AS Model
Expansionary and
Contractionary Fiscal
Policy
Financing of Deficits
and Disposing of
Surpluses
Built-In Stability
Evaluating Fiscal Policy
Problems, Criticisms,
and Complications
Fiscal Policy in the
Open Economy
Forecasting the Future
Key Terms
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FINANCING OF DEFICITS AND
DISPOSING OF SURPLUSES
•Borrowing vs. New Money
•Borrowing From The Public
•Money Creation
•Debt Retirement vs. Idle Surplus
•Debt Reduction
•Impounding
Which Policy Option?
G or T?
Copyright McGraw-Hill/Irwin, 2005
Legislative Mandate
Fiscal Policy and the
AD-AS Model
Expansionary and
Contractionary Fiscal
Policy
Financing of Deficits
and Disposing of
Surpluses
Built-In Stability
Evaluating Fiscal Policy
Problems, Criticisms,
and Complications
Fiscal Policy in the
Open Economy
Forecasting the Future
Key Terms
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End
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BUILT-IN STABILITY
Net tax revenues vary
directly with GDP
Transfer payments behave
the opposite way as tax
collections
Automatic or Built-In
Stabilizers
Economic Importance
Copyright McGraw-Hill/Irwin, 2005
BUILT-IN STABILITY
Legislative Mandate
Expansionary and
Contractionary Fiscal
Policy
Financing of Deficits
and Disposing of
Surpluses
Built-In Stability
Evaluating Fiscal Policy
Problems, Criticisms,
and Complications
Fiscal Policy in the
Open Economy
Forecasting the Future
Key Terms
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End
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Government Expenditures,
G, and Tax Revenues, T
Fiscal Policy and the
AD-AS Model
T
Surplus
G
Deficit
GDP1
GDP2
GDP3
Real Domestic Output, GDP
Copyright McGraw-Hill/Irwin, 2005
Legislative Mandate
Fiscal Policy and the
AD-AS Model
Expansionary and
Contractionary Fiscal
Policy
Financing of Deficits
and Disposing of
Surpluses
Built-In Stability
Evaluating Fiscal Policy
Problems, Criticisms,
and Complications
Fiscal Policy in the
Open Economy
Forecasting the Future
Key Terms
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BUILT-IN STABILITY
Tax Progressivity
• Progressive Tax System
• Proportional Tax System
• Regressive Tax System
The more progressive the
tax system, the greater the
economy’s built-in stability.
Copyright McGraw-Hill/Irwin, 2005
FULL-EMPLOYMENT DEFICITS
Legislative Mandate
Expansionary and
Contractionary Fiscal
Policy
Financing of Deficits
and Disposing of
Surpluses
Built-In Stability
Evaluating Fiscal Policy
Problems, Criticisms,
and Complications
Fiscal Policy in the
Open Economy
Forecasting the Future
Key Terms
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Government Expenditures,
G, and Tax Revenues, T (billions)
Fiscal Policy and the
AD-AS Model
$500
475
450
425
No Change in
Fiscal Policy
b
a
c
GDP2 GDP1
(Year 2) (Year 1)
Real Domestic Output, GDP
Copyright McGraw-Hill/Irwin, 2005
T1
G
FULL-EMPLOYMENT DEFICITS
Legislative Mandate
Expansionary and
Contractionary Fiscal
Policy
Financing of Deficits
and Disposing of
Surpluses
Built-In Stability
Evaluating Fiscal Policy
Problems, Criticisms,
and Complications
Fiscal Policy in the
Open Economy
Forecasting the Future
Key Terms
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End
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Government Expenditures,
G, and Tax Revenues, T (billions)
Fiscal Policy and the
AD-AS Model
$500
475
450
425
Discretionary
Fiscal Policy
Tax Decrease
e
f
d
h
g
GDP4 GDP3
Year 4 Year 3
Real Domestic Output, GDP
Copyright McGraw-Hill/Irwin, 2005
T1
T2
G
EVALUATING FISCAL POLICY
Legislative Mandate
Fiscal Policy and the
AD-AS Model
Expansionary and
Contractionary Fiscal
Policy
Financing of Deficits
and Disposing of
Surpluses
Built-In Stability
Evaluating Fiscal Policy
Problems, Criticisms,
and Complications
Fiscal Policy in the
Open Economy
Forecasting the Future
Key Terms
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Full-Employment Budget
Cyclical Deficit
Recent U.S. Deficits & Surpluses
Year
Actual
Deficit or
Surplus
Full-Employment
Deficit or
Surplus
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
-3.9%
-4.5%
-4.7%
-3.9%
-2.9%
-2.2%
-1.4%
-0.3%
+0.8%
+1.4%
+2.4%
+1.3%
-1.5%
-2.1%
-2.4%
-2.9%
-2.8%
-2.1%
-2.0%
-1.3%
-0.9%
-0.4%
+0.3%
+1.1%
+0.8%
-1.5%
Copyright McGraw-Hill/Irwin, 2005
GLOBAL PERSPECTIVE
Legislative Mandate
Fiscal Policy and the
AD-AS Model
Expansionary and
Contractionary Fiscal
Policy
Financing of Deficits
and Disposing of
Surpluses
Built-In Stability
Evaluating Fiscal Policy
Problems, Criticisms,
and Complications
Fiscal Policy in the
Open Economy
Forecasting the Future
Key Terms
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BUDGET DEFICITS OR SURPLUSES
AS A PERCENTAGE OF GDP, 2002
-6
-4
-2
0
2
4
Italy
Sweden
Canada
United Kingdom
France
United States
Ireland
Norway
Japan
Source: Organization for Economic Development and Cooperation
Copyright McGraw-Hill/Irwin, 2005
Legislative Mandate
Fiscal Policy and the
AD-AS Model
Expansionary and
Contractionary Fiscal
Policy
Financing of Deficits
and Disposing of
Surpluses
Built-In Stability
Evaluating Fiscal Policy
Problems, Criticisms,
and Complications
Fiscal Policy in the
Open Economy
Forecasting the Future
Key Terms
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PROBLEMS, CRITICISMS,
AND COMPLICATIONS
•Problems of Timing
• Recognition Lag
• Administrative Lag
• Operational Lag
•Political Considerations
• Political Business Cycles
•Offsetting State & Local
Finance
•Crowding-Out Effect
Copyright McGraw-Hill/Irwin, 2005
Legislative Mandate
FISCAL POLICY, AGGREGATE
SUPPLY AND INFLATION
Fiscal Policy and the
AD-AS Model
Expansionary and
Contractionary Fiscal
Policy
Built-In Stability
Evaluating Fiscal Policy
Problems, Criticisms,
and Complications
Fiscal Policy in the
Open Economy
Price level
Financing of Deficits
and Disposing of
Surpluses
AS
Fiscal Policy:
No Complications
P1
Forecasting the Future
Key Terms
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AD1
$490
AD2
$510
Real GDP (billions)
Copyright McGraw-Hill/Irwin, 2005
Legislative Mandate
FISCAL POLICY, AGGREGATE
SUPPLY AND INFLATION
Fiscal Policy and the
AD-AS Model
Expansionary and
Contractionary Fiscal
Policy
Built-In Stability
Evaluating Fiscal Policy
Problems, Criticisms,
and Complications
Fiscal Policy in the
Open Economy
Price level
Financing of Deficits
and Disposing of
Surpluses
AS
Fiscal Policy:
Showing
Crowding-out Effect
or Net Export
Effect
P1
Forecasting the Future
Key Terms
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AD1 AD’2 AD2
$490
$510
$504
Real GDP (billions)
Copyright McGraw-Hill/Irwin, 2005
Legislative Mandate
FISCAL POLICY IN THE
OPEN ECONOMY
Fiscal Policy and the
AD-AS Model
Expansionary and
Contractionary Fiscal
Policy
Financing of Deficits
and Disposing of
Surpluses
Shocks Originating from Abroad
Built-In Stability
Evaluating Fiscal Policy
Problems, Criticisms,
and Complications
Net Export Effect
Fiscal Policy in the
Open Economy
Forecasting the Future
Key Terms
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Copyright McGraw-Hill/Irwin, 2005
Forecasting the Future
Legislative Mandate
Fiscal Policy and the
AD-AS Model
Expansionary and
Contractionary Fiscal
Policy
Financing of Deficits
and Disposing of
Surpluses
Built-In Stability
Evaluating Fiscal Policy
Problems, Criticisms,
and Complications
Fiscal Policy in the
Open Economy
Forecasting the Future
Key Terms
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The Leading Indicators
• Average Workweek
• Initial Claims for Unemployment
Insurance
• New Orders for Consumer Goods
• Vendor Performance
• New Orders for Capital Goods
• Building Permits for Houses
• Stock Prices
• Money Supply
• Interest-Rate Spread
• Consumer Expectations
Copyright McGraw-Hill/Irwin, 2005
fiscal policy
progressive tax system
Employment Act of 1946
proportional tax system
Council of Economic
regressive tax system
Advisers (CEA)
full-employment budget
expansionary fiscal policy
cyclical deficit
budget deficit
political business cycle
contractionary fiscal policy
crowding-out effect
budget surplus
net export effect
built-in stabilizer
Copyright McGraw-Hill/Irwin, Inc., 2005
BACK
END
Legislative Mandate
Chapter 13
Fiscal Policy and the
AD-AS Model
Expansionary and
Contractionary Fiscal
Policy
Financing of Deficits
and Disposing of
Surpluses
Built-In Stability
Evaluating Fiscal Policy
Problems, Criticisms,
and Complications
Fiscal Policy in the
Open Economy
Forecasting the Future
Key Terms
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Money
and
Banking
Next...
Copyright McGraw-Hill/Irwin, 2005