3. FISCAL POLICY AND THE AD-AS MODEL
Two Options
ā¢ Discretionary Fiscal Policy
ā¢ Non-Discretionary Fiscal
Policy
Expansionary Fiscal Policy
To Reduce Unemploymentā¦
ā¢ Increase Government
Spending
ā¢ Tax Reductions
ā¢ Combinations of the Two
4. Pricelevel
Real GDP (billions)
EXPANSIONARY FISCAL POLICY
Full $20 billion
increase in
aggregate
demand
AD2 AD1
$5 billion initial
increase in spending
the multiplier at work...
P1
$490 $510
AS
5. To Reduce Inflationā¦
ā¢ Decrease Government
Spending
ā¢ Tax Increases
ā¢ Combinations of the
Two
FISCAL POLICY AND THE AD-AS MODEL
Contractionary Fiscal Policy
6. Pricelevel
Real GDP (billions)
CONTRACTIONARY FISCAL POLICY
Full $20 billion
decrease in
aggregate
demand
AD3 AD4
$5 billion initial
decrease in spending
the multiplier at work...
P2
$510 $522
AS
P1
7. FINANCING OF DEFICITS AND
DISPOSING OF SURPLUSES
ā¢Borrowing vs. New Money
ā¢Borrowing From The Public
ā¢Money Creation
ā¢Debt Retirement vs. Idle Surplus
ā¢Debt Reduction
ā¢Impounding
Which Policy Option?
G or T?
8. 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
9. BUILT-IN STABILITY
GDP1 GDP2 GDP3
Real Domestic Output, GDP
GovernmentExpenditures,
G,andTaxRevenues,T
Deficit
Surplus
T
G
10. BUILT-IN STABILITY
Tax Progressivity
ā¢ Progressive Tax System
ā¢ Proportional Tax System
ā¢ Regressive Tax System
The more progressive the
tax system, the greater the
economyās built-in stability.
11. FULL-EMPLOYMENT DEFICITS
GDP2 GDP1
Real Domestic Output, GDP
GovernmentExpenditures,
G,andTaxRevenues,T(billions)
G
T1
(Year 1)(Year 2)
ab
c
$500
475
450
425
No Change in
Fiscal Policy
12. FULL-EMPLOYMENT DEFICITS
GDP4 GDP3
Real Domestic Output, GDP
GovernmentExpenditures,
G,andTaxRevenues,T(billions)
T2
G
T1
Year 3Year 4
de
f
$500
475
450
425
Discretionary
Fiscal Policy
Tax Decrease
h
g
14. -6 -4 -2 0 2 4
Italy
Sweden
Canada
United Kingdom
France
United States
Ireland
Norway
Japan
GLOBAL PERSPECTIVE
BUDGET DEFICITS OR SURPLUSES
AS A PERCENTAGE OF GDP, 2002
Source: Organization for Economic Development and Cooperation
15. PROBLEMS, CRITICISMS,
AND COMPLICATIONS
ā¢Problems of Timing
ā¢Recognition Lag
ā¢Administrative Lag
ā¢Operational Lag
ā¢Political Considerations
ā¢Political Business Cycles
ā¢Offsetting State & Local
Finance
ā¢Crowding-Out Effect
16. FISCAL POLICY, AGGREGATE
SUPPLY AND INFLATION
Fiscal Policy:
No Complications
Pricelevel
Real GDP (billions)
AD1 AD2
P1
$490 $510
AS
17. FISCAL POLICY, AGGREGATE
SUPPLY AND INFLATION
Fiscal Policy:
Showing
Crowding-out Effect
or Net Export
Effect
Pricelevel
Real GDP (billions)
AD1 AD2
P1
$490 $510
AS
ADā2
$504
18. FISCAL POLICY IN THE
OPEN ECONOMY
Shocks Originating from Abroad
Net Export Effect