1 Chapter 7 Fiscal Policy These slides supplement the textbook, but should not replace reading the textbook.

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Chapter 7 Fiscal Policy

These slides supplement the textbook, but should not replace reading the textbook

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Who were theClassical Economists?A group of the 18th and 19th centuries, including Adam Smith known as the father of modern day economics

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What did Adam Smith and the Classical

Economists believe?The economy was always tending toward a full employment equilibrium and stable prices

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What doeslaissez-faire mean?

Leave well enough alone, let the economy correct problems itself

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What happened in the Depression of 1921?

Even though it was serious the government practiced laissez-faire and the economy recovered in a short period of time

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What were policies of President Herbert Hoover

in the early 1930s to combat the depression?

public works projects raised taxes loans to failing firms relief programs

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What were policies of President Franklin

Roosevelt in 1933 to combat the depression? public works projects and

social welfare programs raised taxes and wages loans to failing firms relief programs

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According to Robert Reich, an American political

economist and professor, what was the result of these

government programs?

These programs helped save American capitalism

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According to Thomas Woods author of Meltdown, what

was the result of these government programs?

These programs prevented the economy from seeking its equilibrium of full employment and prolonged the depression

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What is a fiscal policy?

The manipulation of government purchases, transfer payments, taxes, and borrowing in order to positively influence the economy

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How did Keynes influence fiscal policies?He argued that fiscal policies may be necessary to bring about full employment

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How did World War II affect fiscal policies?It showed that a government stimulus package can work

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What is theEmployment Act of 1946?Its main purpose was to lay the responsibility of economic stability of inflation and unemployment onto the federal government

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What are the four phases of the

business cycle?• trough• recovery• peak• recession

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What are the 3 pillars of

Keynesian Economics?

• Liquidity trap• Balanced budget multiplier• Paradox of thrift

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What is a liquidity trap?

A lack of borrowing keeps money bottled up in savings institutions

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What is the Keynesian solution to

a liquidity trap?Government borrows the money that consumers and business do not borrow

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What is the Balanced Budget

Multiplier?When the government taxes and spends the money there is a multiple effect because of no savings

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What is the Paradox of Thrift?

The more people save, the less will be demand, which leads to slow growth

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What does crowding out mean?

During periods of full employment the government can borrow money that otherwise would be spent or invested

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How does the government borrow

money?It sells bonds (securities) to the Fed or in the Open Market

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What is the current national debt?

Just over $17.5 trillionhttp://www.usdebtclock.org/

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What does monetizing the debt mean?

The federal government sells bonds (securities) to the Fed and the Fed creates the money to buy the bonds

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What can monetizing the debt lead to?

A fall in the value of the dollar and inflation

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What is a discretionary fiscal

policy?Government policies that require ongoing decisions by policy makers

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What are some examples of fiscal policies?

Government purchasesTransfer paymentsTaxes

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What are automatic stabilizers?

Structural features of government spending and taxation smooth out fluctuations in booms and busts

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What are some examples of

automatic stabilizers?Unemployment paymentsWelfareOther govt. programs

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What is the point of Keynesian Economics?The economy could be stuck at equilibrium below the potential output for a prolonged period of time

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What is an expansionary fiscal policy?

An increase in government purchases, decrease in net taxes, or some combination of the two aimed at increasing aggregate demand

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When would the government use

expansionary fiscal policies?

To stimulate the economy when unemployment is greater than the natural rate

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What is a contractionary fiscal policy?

A decrease in government purchases, increase in net taxes, or some combination of the two aimed at reducing aggregate demand

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When would the government use

contractionary fiscal policies?

To slow down the economy when inflation is more than desired

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What is the typical Keynesian policy

during recessions?To use discretionary fiscal policies to stimulate the economy to a full employment equilibrium

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What is the multiplier?

Any change in the level of spending has a multiple effect on GDP

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What is the accelerator?Any increase in spending can lead to an increase in secondary spending, for example, a new highway may lead to more restaurants, hotels, and gas stations

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When does the accelerator have most impact on spending?

During periods of full employment

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How did World War II affect fiscal policies?It showed that a government stimulus package can work

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What is MPC?The marginal propensity to consume (MPC) is a measure of how much consumers will spend out of any addition to their income

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What is MPS?The marginal propensity to save (MPS) is a measure of how much consumers will save out of any addition to their income

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If MPC is ¾, what is MPS?

MPS would be ¼ because MPC + MPS = 1

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What is the value of the multiplier?

1 / MPS

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If MPC is ¾, what is the value of the

multiplier?1 / ¼ = 4

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$100.00$75.00$56.25$42.19$31.64

...

$400.00

original spent

total money

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What effect does an increase in demand have

on prices and output?The more steeply sloped the supply curve the greater impact on prices and the less impact on employment

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Slightly sloped Supply Curve

Real GDP

PriceLevel SRAS

AD

AD*

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Steeply sloped Supply Curve

Real GDP

PriceLevel SRAS

AD

AD*

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How effective are fiscal policies?

Automatic stabilizers are more effective than are discretionary fiscal policies

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Should we rely on automatic stabilizers?

The stronger and more effective the automatic stabilizers are, the less need there is for discretionary fiscal policies

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How effective were fiscal policies during the

stagflation of the 1970’s?

Whatever we did to fight one problem we made the other problem worse

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What are lag effects?Recognition lagDecision lagAction lag

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Do lag effects influence discretionary

fiscal policies?Yes, they weaken fiscal policies as a tool of economic stabilization

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What is one’spermanent income?

Income that individuals expect to receive on average over the long term

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Do consumers base their decisions on their

permanent income or their short term income?

Perceived long term income

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What is one thing policy makers often overlook?

How fiscal policies unintentionally affect individual incentive to work, save and invest

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What is theLaffer Curve?

A curve that shows that starting from zero an increase in taxes will raise revenue but beyond a point an increase will lower revenues

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What is the Laffer Curve?

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What issupply side economics?The belief that real GDP can be increased by giving people incentives to work

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What was fiscal policy in the Reagan Administration

of the 1980’s?Taxes were decreased to stimulate the economy by increasing aggregate supply

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What effect does politics have on fiscal policies?There is always the danger that politicians can use discretionary fiscal policies to suit their short term political goals

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Does the federal deficit affect fiscal policies?If we were to increase spending by borrowing, the national debt could become unmanageable

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Watch video on the National Debt

http://video.search.yahoo.com/video/play?p=national+debt&n=21&ei=utf-8&js=1&fr2=tab-web&tnr=20&vid=000165545891

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What is the difference between a stock and a flow way of thinking? An example of a stock situation would be an increase in government spending has no opportunity costs

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If we spend a dollar do we pay for that

dollar here and now? Yes, either by higher taxes, higher interest rates if we borrow the money, or more inflation if we create the money

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END