12
Fiscal Policy
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Fiscal Policy
• Deliberate changes in:
• Government spending
• Taxes
• 2009 Stimulus Package included
•
LO1
roughly $550 billion in new spending
and $275 billion in tax reductions.
Designed to:
• Achieve full-employment
• Control inflation
• Encourage economic growth
30-2
Expansionary Fiscal Policy
• Used during a recession
• Increase government spending
• Decrease taxes
• Combination of both
• Creates a deficit
LO1
30-3
Expansionary Fiscal Policy
$5 billion
increase in
spending
Recessions
Decrease AD
Price level
AS
Full $20 billion
increase in
aggregate demand
P1
AD1
AD2
$490
What is
the
MPC?
$510
Real GDP (billions)
LO1
30-4
Contractionary Fiscal Policy
• Used during demand-pull inflation
• Decrease government spending
• Increase taxes
• Combination of both
• Create a surplus
LO1
30-5
Contractionary Fiscal Policy
$3 billion initial
decrease in
spending
Price level
AS
P2
P1
c
Full $12 billion
decrease in
aggregate demand
b
a
AD2
AD
AD1 3
$510 $522
Real GDP (billions)
LO1
30-6
Policy Options: G or T?
• To expand the size of government
• If recession, then increase
•
LO1
government spending
• If inflation, then increase taxes
To reduce the size of government
• If recession, then decrease taxes
• If inflation, then decrease
government spending
30-7
Built-In Stability
• Automatic stabilizers
• Taxes vary directly with GDP
• Transfer payments vary inversely with
•
•
LO2
GDP
Reduces severity of business fluctuations
Progressive tax system
30-8
Built-In Stabilizers
Government expenditures, G,
and tax revenues, T
T
Surplus
G
Deficit
Note: The red
line,
indicating
govt.
expenditures,
should
actually
slope
downward.
Why?
GDP1 GDP2
GDP3
Real domestic output, GDP
LO2
30-9
Recent U.S. Fiscal Policy
Federal Deficits (-) and Surpluses (+) as Percentages of GDP, 2000-2009
(1)
Year
(2)
Actual
Deficit – or
Surplus +
(3)
Cyclically
Adjusted
Deficit – or
Surplus +*
2000
+2.4
+1.1
2001
+1.3
+0.5
2002
-1.5
-1.3
2003
-3.4
-2.7
2004
-3.5
-3.2
2005
-2.6
-2.5
2006
-1.9
-2.0
2007
-1.2
-1.2
2008
-3.2
-2.8
2009
-9.9
-7.3
•As a percentage of potential GDP
Source: Congressional Budget Office, http://www.cbo.gov.
LO3
30-13
Budget Deficits and Projections
Actual
Projected
Budget Deficit (-) or Surplus, Billions
$200
0
-200
-400
-600
-800
-1000
-1200
-1400
-1600
1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014
Source: Congressional Budget Office, http://www.cbo.gov.
LO4
30-15
Global Perspective
LO4
30-16
The U.S. Public Debt
Debt held
outside
the Federal
government
and the
Federal
Reserve:
57%
LO4
Debt held by
the Federal
government
and the
Federal
Reserve:
43%
30-20
Crowding-Out Effect
This diagram
demonstrates
the “crowding
out” effect.
Real interest rate (percent)
16
14
12
b
10
8
a
6
Crowding-out
effect
4
ID2
2
ID1
0
LO4
c
Increase in
investment
demand
5
10 15 20 25 30 35
Investment (billions of dollars)
40
However, most
economists
believe that
increased AD will
spur businesses
to new investment
(increase
investment
demand) if the
economy is not at
full employment.
30-25