13 Fiscal Policy

In the depths of the Great Recession, the government authorized a second round of tax refunds.

In both years, the wak explains why the Ricardian equivalence government's intent was to boost the after-tax theorem calls into question the incomes of individuals and families receiving the usefulness of tax changes.
The result, so the government hoped, would be greater household spending on final to engage in fiscal "fine-tuning" goods and services that would contribute to higher wak.

A total of almost $300 billion more has been spent by many states.

Inflation-adjusted federal government expenditures are 30 percent higher than they were in 2008.

In this chapter, you will learn how government spending and taxation affect GDP and the price level.

High employment, price stabil expenditures, and taxes are some of the national goals.

Fiscal policy can be thought of as a deliberate attempt to economic goals, such as high employment, that cause the economy to move to full employment and price stability more quickly than with price stability.

Keynes's explanation of the Great Depression was that there was insufficient aggregate demand.

He argued that the classical economists' picture of an economy moving quickly toward full employment was incorrect because he believed that wages and prices were sticky downward.
Keynes and his followers wanted the government to increase demand.
The federal government started an expansionary fiscal policy to ward off recessions.

Fiscal policy should be looked at first in the context of a recessionary gap.

Spending entities in the economy include firms, individuals, and foreign residents.

The dollar value of total spending must rise when the government spends more.

Real GDP cannot be sustained indefinitely because it exceeds the long-run aggregate supply.

The price level will go from 130 to 120.

Spending decisions of firms, individuals, and other countries' residents are dependent on taxes levied on them.

Consumers look to their disposable income when determining their rates of consumption.

Firms look at their profits when making investment decisions.

Foreign residents look at the tax-inclusive cost of goods when buying in the United States.
Increasing taxes causes a reduction in aggregate demand because it reduces consumption, investment, and net exports.

The aggregate demand curve is shifted to the left by an increase in taxes.

The level of real GDP has fallen from $15.5 trillion per year to 15 trillion per year.
The price level goes from 120 to 100.

The aggregate demand curve is shifted to the right by a decrease in taxes.

The answers can be found on page 294.

The government can cause the national goals to be high employment or reduced inflation by spending to address a situation in which there is a gap.

A shift in the aggregate demand curve to taxes can lead to an increase in the equilibrium level of real GDP per year.

If there is an inflationary gap, the year will increase.

Real GDP can be decreased by taxes.

Fiscal policy works in a bigger picture.

This is where we consider them in detail.

An increase in government expenditures is the first example of fiscal policy in this chapter.

Something has to give if taxes are held constant.
Goods and services are not simply taken by the government.
It must borrow when it doesn't collect the same amount in taxes.
That means that an increase in government spending without raising taxes creates more government borrowing from the private sector.

If the government tries to borrow more money from the private sector, it will have to offer a higher interest rate in order to get more money from people.

Expansionary fiscal policy financed by borrowing from the public has an interest rate effect.
Interest rates will go up when the federal government finances go up.
Firms are less profitable when interest rates go up.
It costs more to finance purchases of cars and homes for individuals.

The positive effect of increased government spending on aggregate demand is offset by a rise in government spending.

In the extreme case, the crowding out may be complete, with the increased govern, the tendency of expansionary fiscal policy to ment spending having no net effect on aggregate demand.

The result is a decrease in planned investment or more government spending.

The rise in below shows how the crowding-out effect occurs.

Consider a firm that is considering borrowing $100,000 to expand its business.

The interest rate could be 5 percent.

The interest on the debt will be five times the amount of the debt.
The payments will increase to 8 percent of $100,000, or $8,000 per year, if the interest rate goes up.
Some firms will not make the investment because of the extra $250 per month in interest expenses.
People face the same decisions when buying houses and cars.
An increase in the interest rate causes their monthly payments to go up, which makes it harder for them to buy cars and houses.

Expansionary fiscal policy pushes up interest rates.

The effect of expansionary fiscal policy is diminished by crowding out.

Economists assume that people only look at changes in taxes and government spending now.

Some economists think that the answer is yes.

Consider an example.

In 2008 and 2009, the government reduced taxes by $150 billion through tax "rebate" programs.
Assume that government spending is constant.
The government initially has a balanced budget.
The only way for the government to pay for this tax cut is to borrow money.
$150 billion will be owed by the public later.
Realizing that a $150 billion tax cut is equivalent to $150 billion plus interest later, people may wish to save the proceeds from the tax cut to meet future tax liabilities.

Total planned expenditures may not be affected by a tax cut.

Aggregate demand may not be affected by a reduction in taxes without a reduction in government spending.
An increase in taxes without an increase in government spending may not have a big impact on demand.

Fiscal policy doesn't matter if expenditures are financed by taxes or borrowing.

Research shows that there is likely to be a Ricardian equivalence effect, but there is not much evidence about their magnitudes.

The government has an advantage over the private sector in certain activities.

The government's activities do not compete with the private sector.
Some of what government does, such as public education, competes with the private sector.

This is the case for a missile.

A rise in government spending causes a reduction in private spending to offset it.

We end up with a relabeling of spending from private to public when the direct expenditure offset is dollar for dollar.

You should spend $100 on groceries.
At the checkout counter, you will find a U.S. Department of Agriculture official.
She will only pay for the ones in the cart.
There has been an increase in government spending of $100.
You leave the store happy.
Just as you are making a decision on how to spend the $100, an IRS agent shows up.
The current budgetary crisis will cause your taxes to rise by $100.
You have to pay.
Taxes have gone up by $100.
There is an increase in government spending.
We end up with higher government spending because of an equal reduction in consumption.
Aggregate demand and GDP are not different.
The government spending multiplier is zero if there is a full direct expenditure offset.

Private-sector spending is a substitute for government spending.

Private spending tends to decline when government expenditures increase, so that the upward impact on total aggregate demand is mitigated.

Predicted changes in aggregate demand will be lessened if there are some direct expenditure offsets.

The price level will be less affected.

Changing taxes and government spending are traditional fiscal policy tools.

The marginal tax rate is the rate that is applied to the highest level of taxable income.
As income increases, higher marginal tax rates are applied.
The United States has a progressive federal individual income tax system.
Reducing marginal tax rates could be part of expansionary fiscal policy.
Lowering tax rates will lead to an increase in productivity because individuals will work harder and longer, save more, and invest more, and that will lead to more economic growth, which will lead to higher real GDP.
The lower marginal tax rates will be applied to a growing tax base because they are the product of a tax rate times a tax base.

The Laffer curve shows when tax revenues rise with a higher tax rate.

As the tax rate increases, tax revenues decline.

Arthur Laffer is an economist who explained the relationship between policy choices and discretionary fiscal in 1974.

Changing the tax structure to create incentives to increase productivity is one suggestion.

Increased real GDP will cause the aggregate supply curve to shift without upward pressure on the price level.

Take into account the effects of changes in marginal tax rates on labor.

The opportunity cost of leisure is reduced by an increase in tax rates.
Increasing tax rates will reduce spendable income and shift the demand curve for leisure to the left, which will increase work effort.
The choice of leisure depends on which of the two effects is stronger.

Workers have been affected by increases in marginal tax rates and decreases in marginal tax rates.

In recent years, several economists have conducted studies of the effects of tax cuts on GDP, taking into account changes in discretionary fiscal policy on real GDP.

Changes in plier effects, crowding out, and changes in the price level are all on a dollar-for-dollar basis.
Government spending exerts effects on real GDP that are at most half the examined effects on real GDP up to two years after the initial policy effects of tax cuts.

The answers can be found on page 294.

The government's efforts to finance its future taxes will increase and therefore save more today to deficit spending cause interest rates to be paid for by them.

Government tax receipts can increase.

The private sector competes with ernment spending.

There is a possibility of a direct crowding-out effect.

Fiscal policy can be discussed in a precise way.

We draw graphs to show what we are doing.
We could estimate the offsets that we just talked about.
The conduct of fiscal policy involves a variety of time lags, and even if we were able to measure all of these offsets exactly, would-be fiscal policymakers still face a problem.

Time lags must be taken into account by policymakers.

It's difficult to measure economic variables and it takes a lot of time to collect them.

A solution must be formulated after an economic problem is recognized.

The time between recognizing an economic is called the action time lag.

The policy must be approved by Congress and implemented to solve the political problem.

The action time lag for fiscal policy requires congressional approval.

It takes time after Congress passes fiscal policy legislation to decide who gets new federal construction contracts.

Implementation of a policy and its effects take a long time to work their way through the economy, because the time that elapses between the shift curves on a chalkboard, a whiteboard, or a piece of paper is in the real world.

Because the fiscal policy time lags are long, a policy designed to combat a significant recession such as the Great Recession of the late 2000s might not produce results until the economy is already out of that recession and possibly experiencing inflation, in which case the fiscal policy action would worsen the situation.

A fiscal policy designed to eliminate inflation might not work until the economy is in a recession.
Fiscal policy would make the economic problem worse.

Fiscal policy is more complicated than science.

Changes in taxes or government spending are not discretionary fiscal policy.

There are several types of fiscal policies.
Changes in desired aggregate and income transfer payments are caused by unemployment compensation.

You know that if you work less, you pay less taxes.

During a recession, the amount of taxes the government collects falls.

When business activity slows down and the government's tax revenues decline, incomes and profits fall.
An automatic tax cut stimulates aggregate demand according to some economists.
It reduces the amount of economic fluctuations.

The federal personal and corporate income tax systems are progressive.

If your hours of work are reduced, you still have to pay federal income taxes.
You can pay a lower marginal tax rate because of our progressive system.

Unemployment compensation payments are similar to our tax system.

Most laid off workers will be eligible for unemployment compensation from their state governments.
Their disposable income is still positive, but it is at a lower level than when they were employed.
Unemployment payments are made to the labor force less during boom periods.
Less purchasing power is being added to the economy.
The opposite is true during a recession.

Income transfer payments are an automatic stabilizer.

Supplemental Security Income and Temporary Assistance to Needy Families are some of the income transfer payments that people become eligible for.
People don't experience as dramatic a drop in disposable income as they would have.

The key stabilizing impact of our tax system, unemployment compensation, and income transfer payments is their ability to mitigate changes in disposable income, consumption, and the equilibrium level of real GDP.

The downturn will be moderated if disposable income is prevented from falling as much as it otherwise would.
The boom is less likely to get out of hand if disposable income is prevented from rising as rapidly as it otherwise would.

Tax revenues and government transfers are assumed to remain constant as real GDP increases.

There is a budget surplus.

There is a budget deficit.

Automatic changes tend to drive the economy back to full employment.

There are two ways to look at fiscal policy.

One prevails during normal times and the other during abnormal times.

During normal times, we know that due to the recognition time lag and the about expanding spending and budget deficits modest size of any fiscal policy action that Congress will actually take, discretionary of the U

Congress doesn't do enough to help in a small recession.

Fiscal policy that creates tax changes may do more harm than good.

If fiscal policy has any effect during normal times, it is achieved by way of automatic stabilizers rather than by way of discretionary policy.

Fiscal policy may be effective during abnormal times.

The Great Depression and war periods are examples.

Fiscal policy may be able to increase aggregate demand when real GDP goes down as it did during the Great Depression.

Government spending is a way to get income into the hands of people who are income-constrained because they have few assets left.

Wars are reserved for governments.

War expenditures have little or no direct expenditure offsets.

During World War II, when real GDP increased dramatically, war spending as part of expansionary fiscal policy had noteworthy effects.

One view of Keynesian fiscal policy does not call for it to be used on a regular basis, but it does see it as potentially useful.

Many problems are associated with trying to use fiscal policy.
Fiscal policy is available in the event of a severe downturn.
Consumers and investors may be reassured by knowing this.
The availability of fiscal policy may make people more optimistic about the future.

The answers can be found on page 294.

Discretionary fiscal policy may not be a policy.

The time lag, the useful policy tool in normal times because of time lags, and the time lag are included.

The existence of fiscal policy Two, or built-in, stabilizers may have a soothing effect on consumers and investors.

Changes in disposable income are caused by changes in business activity.

White House Budget Director Peter Orszag believes that the only way to bring revenues and spend is anticipating that the government's tax revenues will fall short.

Orszag and the rest of the White House are hoping that increased will be able to make up for the effects of higher tax rates on the economy by spending more money.

An increase in the top tax rate on corporate dividends from 1930s could be stopped.

An annual government expenditure of almost $10 billion is expected to be generated by the introduction of a new tax rate on bank liabilities.

In 2008 and again in 2009, the U.S. government implemented fiscal policy actions in the form of one-time tax refunds.

Real disposable incomes and real consumption spending would be boosted by N Supply-Side Economics.

Significant personal income and personal consumption expenditures increases in real consumption expenditures did not happen since January 2007.

There is a figure that shows disposables.
After the federal government transmitted tax higher real consumption expenditures failed, the attempt to stimulate economic activity via income rose.

The Congressional Budget Office evaluation did not boost consumption spending.

The effects of tax rebates can be found at www.econtoday.com.

For an analysis of why the 2008 and 2009 tax refunds had small effects on consumption spending, go to www rowing, so a number of households responded as predicted.

They saved the money so they wouldn't have to pay higher taxes later.

The tax cuts were temporary.

Section N: News, why do you think that reductions in tax rates have larger effects on real consumption spending and real GDP?

You should know what to know after reading this chapter.

In a recession, current real GDP is less than the long-run level.

An intentional reduction in government should leave farm business spending or a tax increase shifts the aggregate.

13-5 ment spending exceeds tax revenues so the figures were borrowed from the private sector.

Increased government spending may substitute directly for private expenditures, and the resulting decline in private spending directly offsets the increase in total planned expenditures that the government had intended to bring about.

Figure 13-4, 282 taxes will have to increase in the future.

They have to save the tax cut proceeds to meet their future tax obligations.
A tax cut fails to increase aggregate consumption spending and thus has no effect on total planned expenditures and aggregate demand.

Policy time lags are complicated by the policy actions intended to bring about changes.

The time needed to collect information about the economy's current situation is called the recognition time lag.
The action time lag is the period between the recognition of a problem and the implementation of a policy intended to address it.
The effect time lag is the interval between the implementation of a policy and it having an effect on the economy.

Automatic reduction in income tax collections and increases in unemployment compensation and income transfer payments tend to minimize the reduction in total planned expenditures when there is a decline in real GDP.

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The nation's economic performance would be weakened if Congress and the president decided to build a classical music museum.

Determine if each of the following changes are changes or if they are new laws that will cause indirect crowding out.

The government provides a subsidy to help action, careful studies by government econo keep an existing firm operating, even though a rise in government expenditures on equilib vided a cash injection that would have kept the firm afloat.

It has become clear that the government reduces its taxes without ever decreasing its expenditures.

The result effect on real GDP will be less than half of the budget deficit.

A year and a half has passed since the passage of the interest rate.

Investment spending is governed by the govern.

There have been no other events of a high-rise office building on a plot of land significance.

By the end of the year, real GDP has returned to its original construction, even though a private company wouldn't have built it.

There is a possible explanation for this outcome.

Suppose that Congress passes a tax cut of more than 100,000 square feet that will be used for the study of infectious diseases.

There was late aggregate demand and push up real GDP prior to the construction of these buildings.
In fact, neither real GDP universities had been planning to build essentially nor the price level changes significantly as the same facilities using privately obtained funds.

There is a direct expenditure offset to fiscal policy when there is a recession.

Congress votes to fund a new jobs program that will put unemployed workers to work.

The Federal Reserve reduces the amount of money in circulation in an effort to use it more frequently.

The act of Congress gave the power to be used without raising taxes.

When the president decides to authorize an emergency budget deficit, it borrows more funds from the release of funds for spending programs intended private sector, thus pushing up the market to head off economic crises.

Whenever an economic downturn begins, a government agency makes loans to businesses.

The government's budget is balanced.

There is a marginal propensity to consume.

As a percentage of White House internet address, revenue sources declined as federal budget data showed.

The Office of Management and Budget can be found at the link at www.econtoday.com/ch13 Government Outlays by Function.

The percentage function is in Table 2.2.

The Keynesian approach to fiscal policy is different in three ways.

The components of aggregate demand are emphasized first.
Government expenditures are not a substitute for private expenditures and current taxes are the only taxes taken into account by consumers and firms.
The Keynesian approach focuses on the short run and assumes that the price level is constant.

Consumption depends on real GDP.

Real GDP is equal to planned real spending along the 45 degree reference line.
Real GDP will tend to rise when spending exceeds it.
Spending will decline if planned spending is less than real GDP.

The rise in real government spending leads to a rise in real GDP, which in turn leads to a rise in consumption spending.

According to the Keynesian approach, changes in current taxes affect aggregate demand by changing the amount of disposable income available to consumers.

A rise in taxes reduces disposable income and thus reduces real consumption, while a tax cut raises disposable income and causes a rise in consumption spending.
Figure D-2 shows the effects of a tax increase.
The decline in consumption will be less than the increase in taxes because people will reduce their saving to pay the higher taxes.

The impact of a balanced-budget change in government real spending is an interesting implication of the Keynesian approach.

If the government increases spending by $1 billion and raises taxes by $1 billion, it will pay for it.

A balanced-budget reduction in government spending will cause total spending to fall.

The Keynesian approach assumes that the price level is fixed as a first approximation.

The nominal GDP is equal to the price level.
If additional factors of production, such as labor, are utilized, the additional real GDP can be produced.

There is a marginal propensity to save.

If government expenditures increase by $2 billion.

Asking lowing questions.