12 - 1 Copyright McGraw-Hill/Irwin, 2005 Legislative Manda te Fiscal Policy and the AD-AS Model Expansionary and Contractionary Fi scal Policy Financing of Defi cits and Disposin g of Surpluses Built-In Stabilit y Evaluating Fiscal Policy Problems, Criticisms, and Complications Fiscal Policy in the Open Economy Forecasting the Future Key Terms Previo us Slide Next Slid e End End Show Show FISCAL POLICY 12 C H A P T E R
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12 - 1Copyright McGraw-Hill/Irwin, 2005
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
PreviousSlide
NextSlide
EndEndShowShow
FISCALPOLICY
12C H A P T E R
12 - 2Copyright McGraw-Hill/Irwin, 2005
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
PreviousSlide
NextSlide
EndEndShowShow
LEGISLATIVE MANDATES
Employment Act of 1946
Council of Economic
Advisors (CEA)
Joint Economic
Committee (JEC)
12 - 3Copyright McGraw-Hill/Irwin, 2005
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
PreviousSlide
NextSlide
EndEndShowShow
FISCAL POLICY AND THE AD-AS MODEL
Two Options• Discretionary Fiscal Policy • Non-Discretionary Fiscal
PolicyExpansionary Fiscal PolicyTo Reduce Unemployment…• Increase Government
Spending• Tax Reductions• Combinations of the Two
12 - 4Copyright McGraw-Hill/Irwin, 2005
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
PreviousSlide
NextSlide
EndEndShowShow
Pri
ce le
vel
Real GDP (billions)
EXPANSIONARY FISCAL POLICY
Full $20 billionincrease in aggregatedemand
AD2 AD1
$5 billion initialincrease in spending
the multiplier at work...
P1
$490 $510
AS
12 - 5Copyright McGraw-Hill/Irwin, 2005
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
PreviousSlide
NextSlide
EndEndShowShow
To Reduce Inflation…• Decrease Government
Spending• Tax Increases• Combinations of the
Two
FISCAL POLICY AND THE AD-AS MODEL
Contractionary Fiscal Policy
12 - 6Copyright McGraw-Hill/Irwin, 2005
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
PreviousSlide
NextSlide
EndEndShowShow
Pri
ce le
vel
Real GDP (billions)
CONTRACTIONARY FISCAL POLICY
Full $20 billiondecrease in aggregatedemand
AD3 AD4
$5 billion initialdecrease in spending
the multiplier at work...
P2
$510 $522
AS
P1
12 - 7Copyright McGraw-Hill/Irwin, 2005
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
PreviousSlide
NextSlide
EndEndShowShow
FINANCING OF DEFICITS ANDDISPOSING OF SURPLUSES
•Borrowing vs. New Money•Borrowing From The Public•Money Creation
•Debt Retirement vs. Idle Surplus•Debt Reduction•Impounding
Which Policy Option? G or T?
12 - 8Copyright McGraw-Hill/Irwin, 2005
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
PreviousSlide
NextSlide
EndEndShowShow
BUILT-IN STABILITYNet tax revenues vary
directly with GDPTransfer payments behave
the opposite way as tax collections
Automatic or Built-In Stabilizers
Economic Importance
12 - 9Copyright McGraw-Hill/Irwin, 2005
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
PreviousSlide
NextSlide
EndEndShowShow
BUILT-IN STABILITY
GDP1 GDP2 GDP3
Real Domestic Output, GDP
Gov
ern
men
t E
xpen
dit
ure
s,G
, an
d T
ax R
even
ues
, T
Deficit
Surplus
T
G
12 - 10Copyright McGraw-Hill/Irwin, 2005
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
PreviousSlide
NextSlide
EndEndShowShow
BUILT-IN STABILITY
Tax Progressivity• Progressive Tax System• Proportional Tax System• Regressive Tax System
The more progressive the tax system, the greater the economy’s built-in stability.
12 - 11Copyright McGraw-Hill/Irwin, 2005
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
PreviousSlide
NextSlide
EndEndShowShow
FULL-EMPLOYMENT DEFICITS
GDP2 GDP1
Real Domestic Output, GDP
Gov
ernm
ent
Exp
endi
ture
s,G
, and
Tax
Rev
enue
s, T
(bi
llio
ns)
G
T1
(Year 1)(Year 2)
ab
c$500 475 450 425
No Change inFiscal Policy
12 - 12Copyright McGraw-Hill/Irwin, 2005
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
PreviousSlide
NextSlide
EndEndShowShow
FULL-EMPLOYMENT DEFICITS
GDP4 GDP3
Real Domestic Output, GDP
Gov
ernm
ent
Exp
endi
ture
s,G
, and
Tax
Rev
enue
s, T
(bi
llio
ns) T2
G
T1
Year 3Year 4
de
f$500 475 450 425
DiscretionaryFiscal PolicyTax Decrease
h
g
12 - 13Copyright McGraw-Hill/Irwin, 2005
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
PreviousSlide
NextSlide
EndEndShowShow
EVALUATING FISCAL POLICYFull-Employment BudgetCyclical DeficitRecent U.S. Deficits & Surpluses
Year
ActualDeficit orSurplus
Full-EmploymentDeficit orSurplus
1990199119921993199419951996199719981999200020012002
-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%
-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%
12 - 14Copyright McGraw-Hill/Irwin, 2005
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
PreviousSlide
NextSlide
EndEndShowShow
-6 -4 -2 0 2 4
Italy
Sweden
Canada
United Kingdom
France
United States
Ireland
Norway
Japan
GLOBAL PERSPECTIVEBUDGET DEFICITS OR SURPLUSESAS A PERCENTAGE OF GDP, 2002
Source: Organization for Economic Development and Cooperation
12 - 15Copyright McGraw-Hill/Irwin, 2005
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
PreviousSlide
NextSlide
EndEndShowShow
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
12 - 16Copyright McGraw-Hill/Irwin, 2005
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
PreviousSlide
NextSlide
EndEndShowShow
FISCAL POLICY, AGGREGATE SUPPLY AND INFLATION
Fiscal Policy:No Complications
Pri
ce le
vel
Real GDP (billions)
AD1 AD2
P1
$490 $510
AS
12 - 17Copyright McGraw-Hill/Irwin, 2005
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
PreviousSlide
NextSlide
EndEndShowShow
FISCAL POLICY, AGGREGATE SUPPLY AND INFLATION
Fiscal Policy:ShowingCrowding-out Effector Net ExportEffectP
rice
leve
l
Real GDP (billions)
AD1 AD2
P1
$490 $510
AS
AD’2
$504
12 - 18Copyright McGraw-Hill/Irwin, 2005
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
PreviousSlide
NextSlide
EndEndShowShow
FISCAL POLICY IN THEOPEN ECONOMY
Shocks Originating from Abroad
Net Export Effect
12 - 19Copyright McGraw-Hill/Irwin, 2005
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
PreviousSlide
NextSlide
EndEndShowShow
Forecasting the FutureThe 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
ENDBACK
fiscal policy
Employment Act of 1946
Council of Economic Advisers (CEA)
expansionary fiscal policy
budget deficit
contractionary fiscal policy
budget surplus
built-in stabilizer
progressive tax system
proportional tax system
regressive tax system
full-employment budget
cyclical deficit
political business cycle
crowding-out effect
net export effect
Copyright McGraw-Hill/Irwin, Inc., 2005
12 - 21Copyright McGraw-Hill/Irwin, 2005
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
PreviousSlide
NextSlide
EndEndShowShow
Chapter 13
Moneyand
BankingNext...
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