of 23
8/6/2019 Budget and Fiscal Policy
1/23
Fiscal Policy
Fiscal Policy -- the Federal governmentchanging its government budget
position (G - T) in order to stabilize theeconomy.
Fiscal Policy, by its nature, alters theFederal Budget. This chapter alsoexamines the Federal Budget, what itsmade up of, and when budget deficits
can be a problem in the economy.
8/6/2019 Budget and Fiscal Policy
2/23
The Federal Budget
Budget = Tax Revenues - GovernmentExpenditure (over a given period).
Federal Budget (or Budget) = TaxRevenues - (Government Purchases ofGoods and Services + TransferPayments + Interest on the NationalDebt).
8/6/2019 Budget and Fiscal Policy
3/23
Budget Definitions
Budget < 0 -- Budget Deficit
Budget > 0 -- Budget Surplus
Budget = 0 -- Balanced Budget
Realistic Goal -- Balanced Budgetwhen Y = YF.
8/6/2019 Budget and Fiscal Policy
4/23
The US Federal Budget:2003 (Billions of Dollars)
Tax Revenues $1974.8
Government
Expenditure $2381.3
Federal Budget -$406.5
Source: Economic Indicators,October 2005.
8/6/2019 Budget and Fiscal Policy
5/23
Breakdown ofTax Revenues
Personal Income Taxes = $801.8
Corporate Profits Taxes = $217.4
Taxes on Productionand Imports (e.g. sales
and excise taxes) = $94.0
Contributions forSocial Insurance = $803.5
Other = $58.1
8/6/2019 Budget and Fiscal Policy
6/23
Breakdown ofGovernment Expenditure
Purchases of
Goods and Services (G) = $725.7
Transfer Payments = $1391.2
Interest Payments = $221.5
Other = $42.9
Source: Economic Indicators,October 2005.
8/6/2019 Budget and Fiscal Policy
7/23
The Budget: In Our Notation
Recall variable definitions:
-- T = net taxes
= tax revenues- (transfer payments
+ interest on the
national debt)-- G = government purchases of
goods and services
8/6/2019 Budget and Fiscal Policy
8/23
The Budget andThe Budget Position
Budget = T - G
Budget Position (or size of deficit)= G - T
8/6/2019 Budget and Fiscal Policy
9/23
The National Debt
The National Debt -- The totalaccumulated stock of debt owedby the government to its lenders(holders of government bonds).
Expanded by budget deficits,reduced by budget surpluses.
8/6/2019 Budget and Fiscal Policy
10/23
National Debt --Realistic Goal
Realistic Goal -- consider the
Debt-Income Ratio =
(National Debt)/(GDP). For the US in 2004 =
($4295.5)/($11734.3) = 0.366.
Source: Economic Indicators,October 2005.
8/6/2019 Budget and Fiscal Policy
11/23
The Income Tax andAutomatic Stabilization
Automatic Stabilization -- due tothe income tax system, taxrevenues change in directions thathelp to stabilize the economy,without any change in the tax
structure (i.e. fiscal policy).
8/6/2019 Budget and Fiscal Policy
12/23
The Income Tax as anAutomatic Stabilizer
Y*o (maybe > YF) Tax Revenueso
helps to cool the economy
Y*q (maybe < YF) Tax Revenuesqhelps to stimulate the economy
Note -- all this takes place withoutany change in the tax structure, as
prescribed by fiscal policy.
8/6/2019 Budget and Fiscal Policy
13/23
8/6/2019 Budget and Fiscal Policy
14/23
Strategy of Fiscal Policy
Expansionary policies seek toinduce more purchasing of goodsand services by increasing (G - T)-- i.e. Go or Tq.
Contractionary policies seek toinduce less purchasing of goodsand services by decreasing (G - T)-- i.e. Gq or To.
8/6/2019 Budget and Fiscal Policy
15/23
Specific Typesof Fiscal Policy
Change Government Purchases ofGoods and Services (G)
-- Expansionary: Go
-- Contractionary: Gq
Change Transfer Payments (TP)-- Expansionary: TPo
-- Contractionary: TPq
8/6/2019 Budget and Fiscal Policy
16/23
Tax Policy as Fiscal Policy
Change Marginal Tax Rates (t)-- Expansionary: tq-- Contractionary: to
Change Tax Deductions-- Expansionary: Bigger Deductions
-- Contractionary: Smaller Deductions
Change Indirect Business Taxes
(e.g. Sales or Excise Taxes)-- Expansionary: Lower Taxes
-- Contractionary: Raise Taxes
8/6/2019 Budget and Fiscal Policy
17/23
Fiscal Policyin the AD-AS Model
Expansionary Fiscal Policy shiftsthe AD curve rightward, increases
Y* and P*. Contractionary Fiscal Policy shifts
the AD curve leftward, decreases
Y* and P*. Note -- like monetary policy, fiscal
policy is justified only from a
short-run perspective.
8/6/2019 Budget and Fiscal Policy
18/23
Obstacles toFiscal Policy Effectiveness
Difficulties in getting the properpolicy passed through Congressand the president.
A tax cut that isnt used forspending. AD curve does not shiftrightward, no change in Y*.
Worries about the Federal Budgetwithin a sluggish economy.
8/6/2019 Budget and Fiscal Policy
19/23
The Crowding Out Effect --An Adverse Side Effect
The Crowding Out Effect --Expansionary fiscal policy createsan increased need for moreborrowing by the government.This financing increases the
demand for financial capital. As aresult, long-term interest rates (r*)rise and Investment (I*) decreases.
8/6/2019 Budget and Fiscal Policy
20/23
The Crowding Out Effect --Fiscal Policy Effectiveness
Crowding Out Effect -- makesfiscal policy less effective than
would be otherwise. Decrease in investment to some
extent offsets rise in (G - T).
Smaller shift in AD curve thanwould be without the crowding outeffect.
8/6/2019 Budget and Fiscal Policy
21/23
The Crowding Out Effect Impeding Economic Growth
Crowding Out Effect loss ofInvestment (I).
Decrease in Investment retards thebuildup of the capital stock andpossible implementation of newtechnology (i.e. Labor Productivity
growth). Smaller shifts in LAS curve, smaller
increases in YF.
8/6/2019 Budget and Fiscal Policy
22/23
Ways to Avoid theCrowding Out Effect
Bottom line -- get the supply offinancial capital to shift rightward
at the same time as whenexpansionary fiscal policy occurs.
-- expansionary monetary policy
-- increased private saving
-- increase in foreign capital
inflows
8/6/2019 Budget and Fiscal Policy
23/23
Distinctive Fiscal PolicyActions in the US
World War II
The Kennedy-Johnson Tax Cut of 1964
The Nixon Tax Increase of 1969 The Reagan Economic Recovery and
Tax Act of 1981
Clinton Tax Increases of 1993
Bush Tax Cuts of 2001-03
Bush Tax Rebates of 2008
Obama Fiscal Stimulus Plan of 2009
