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

12
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C HAPTE R

FISCAL POLICY

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LEGISLATIVE MANDATES
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

Employment Act of 1946

Council of Economic Advisors (CEA)

Joint Economic
Committee (JEC)
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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
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EXPANSIONARY FISCAL POLICY

Legislative Mandate Fiscal Policy and the AD-AS Model Expansionary and Contractionary Fiscal Policy

the multiplier at work...

AS Full $20 billion increase in aggregate demand

$5 billion initial increase in spending

Built-In Stability Evaluating Fiscal Policy Problems, Criticisms, and Complications Fiscal Policy in the Open Economy Forecasting the Future Key Terms

Price level

Financing of Deficits and Disposing of Surpluses

P1

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AD2
$490 $510

AD1

Real GDP (billions)

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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

Contractionary Fiscal Policy

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To Reduce Inflation Decrease Government Spending Tax Increases Combinations of the Two
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CONTRACTIONARY FISCAL POLICY

Legislative Mandate Fiscal Policy and the AD-AS Model Expansionary and Contractionary Fiscal Policy

the multiplier at work...

$5 billion initial decrease in spending AS Full $20 billion decrease in aggregate demand

Price level

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

P2

P1

AD3
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AD4

$510 $522

Real GDP (billions)

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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

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

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Which Policy Option? G or T?

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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 Net tax revenues vary directly with GDP Transfer payments behave the opposite way as tax collections Automatic or Built-In Stabilizers Economic Importance
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BUILT-IN STABILITY
Legislative Mandate Fiscal Policy and the AD-AS Model

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

Government Expenditures, G, and Tax Revenues, T

Expansionary and Contractionary Fiscal Policy

Surplus

G
Deficit

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GDP1

GDP2

GDP3

Real Domestic Output, GDP

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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

BUILT-IN STABILITY Tax Progressivity Progressive Tax System Proportional Tax System Regressive Tax System
The more progressive the tax system, the greater the economys built-in stability.
Copyright McGraw-Hill/Irwin, 2005

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FULL-EMPLOYMENT DEFICITS
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

Government Expenditures, G, and Tax Revenues, T (billions)

No Change in Fiscal Policy

b c

T1

$500 475 450 425

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(Year 2) (Year 1)

GDP2 GDP1

Real Domestic Output, GDP

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FULL-EMPLOYMENT DEFICITS
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

Government Expenditures, G, and Tax Revenues, T (billions)

Discretionary Fiscal Policy Tax Decrease

e f g

T1 T2

$500 475 450 425

d h

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Year 4 Year 3
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GDP4 GDP3

Real Domestic Output, GDP

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

Full-Employment Budget Cyclical Deficit

Recent U.S. Deficits & Surpluses
Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
Copyright McGraw-Hill/Irwin, 2005

Actual Deficit or Surplus -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%

Full-Employment Deficit or Surplus -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%

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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

BUDGET DEFICITS OR SURPLUSES AS A PERCENTAGE OF GDP, 2002

-6 -4 -2 0 2 4

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Italy Sweden Canada United Kingdom France United States Ireland Norway Japan
Source: Organization for Economic Development and Cooperation
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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 and the AD-AS Model Expansionary and Contractionary Fiscal Policy

FISCAL POLICY, AGGREGATE SUPPLY AND INFLATION

AS

Built-In Stability Evaluating Fiscal Policy Problems, Criticisms, and Complications Fiscal Policy in the Open Economy Forecasting the Future Key Terms

Price level

Financing of Deficits and Disposing of Surpluses

P1

Fiscal Policy: No Complications

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AD1 $490 $510

AD2

Real GDP (billions)

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Legislative Mandate Fiscal Policy and the AD-AS Model Expansionary and Contractionary Fiscal Policy

FISCAL POLICY, AGGREGATE SUPPLY AND INFLATION

AS

Built-In Stability Evaluating Fiscal Policy Problems, Criticisms, and Complications Fiscal Policy in the Open Economy Forecasting the Future Key Terms

Price level

Financing of Deficits and Disposing of Surpluses

P1

Fiscal Policy: Showing Crowding-out Effect or Net Export Effect

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AD1 AD2 AD2 $490 $510 $504

Real GDP (billions)

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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

FISCAL POLICY IN THE OPEN ECONOMY

Shocks Originating from Abroad
Net Export Effect

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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

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

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fiscal policy Employment Act of 1946 Council of Economic Advisers (CEA)

progressive tax system proportional tax system regressive tax system full-employment budget

expansionary fiscal policy

budget deficit contractionary fiscal policy budget surplus built-in stabilizer
Copyright McGraw-Hill/Irwin, Inc., 2005

cyclical deficit
political business cycle crowding-out effect net export effect

BACK

END

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

Chapter 13

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Money and Banking

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