Macroeconomics Fiscal Policy ECON 321
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Macroeconomics+
Fiscal+Policy+
ECON+321+
Role+of+Government+
• Pareto+Op=mal:+is+an+alloca=on+of+goods+is+
Pareto+Op=mal+if+there+is+no+way+to+rearrange+
the+alloca=on+such+that+at+least+one+agent+is+
beEer+off+without+making+any+other+agent+
worse+off.+
– example:++
• Everyone+has+one+cookie:++ + ++Pareto+Op=mal? +YES+
• One+person+has+all+the+cookies:++Pareto+Op=mal? +???+
Role+of+Government+
• Pareto+Op=mal+isn’t+about+distribu=on,+but+
rather+efficiency…i.e.+there+are+no+wasted+
cookies.+
• A+Compe==ve+Equilibrium+(C.E.)+:+is+a+set+of+
quan==es+and+prices,+given+exogenous+variables+
and+parameters,+such+that+consumers+maximize+
u=lity,+and+firms+maximize+profit,+both+subject+to+
their+constraints+and+taking+all+prices+as+given,+
such+that,+all+markets+clear.+
Role+of+Government+
• The+First+Fundamental+Welfare+Theorem:+
states+that+under+certain+condi=ons,+a+
compe==ve+equilibrium+is+Pareto+Op=mal.+
– Adam+Smith,+laissezZfaire,+the+invisible+hand.+
– Gov’t+not+necessary+for+this+outcome.+
• Condi=ons+(Only+Role+for+Gov’t+are+viola=ons)+1. All+agents+are+price+takers.+2. *All+markets+are+complete.+(no+externali=es)+
3. No+distor=ons+of+incen=ves+(i.e.+wage+tax)+
Policy+
.+New+Keynesians+(saltwater+economists)+
Loca=on:+ + + +mainly+on+coasts+
Key+Assump=on:+ + +prices+are+s=cky+
Main+Driver+of+the++
++Business+Cycle: + +Demand+
Policy+Philosophy:+ +Very+Large+++
+ + + + +Government+Role+
+ + + + +in+Business+Cycle+
Neo+Classicals+(freshwater+economists)+
Loca=on:+ + + +mainly+midwest+
Key+Assump=on: + +prices+adjust+rapidly+
Main+Driver+of+the++
++Business+Cycle: + +Supply+
Policy+Philosophy:+ +LiEle+to+no+Role+for++++++++++
+ + + + +for+Government+in++
+ +++++++++++++++++++++++++++Business+Cycle+
• Obama_Inaugural+
• Obama_Economy+
– Start+to+12+• Reagan_Inaugural+
– Start+to+12+• Reagan_Economy+
– 6:00+to+7:00+– 9:00+to+11:00++
Extra+Credit+Quiz+
• HW5+#1+
GDP+COMPONENTS:+
%+of+GDP+
0+
10+
20+
30+
40+
50+
60+
70+
80+
1948+
1951+
1954+
1957+
1960+
1963+
1966+
1969+
1972+
1975+
1978+
1981+
1984+
1987+
1990+
1993+
1996+
1999+
2002+
2005+
2008+
2011+
%GDP%
Personal+consump=on+expenditures+
Gross+private+domes=c+investment+
Government+consump=on+expenditures+
and+gross+investment+
Government+Consump=on+
Expenditures+and+Gross+Investment+
0+
5+
10+
15+
20+
25+
30+
1948+
1951+
1954+
1957+
1960+
1963+
1966+
1969+
1972+
1975+
1978+
1981+
1984+
1987+
1990+
1993+
1996+
1999+
2002+
2005+
2008+
2011+
%GDP%
Government+Total+ ++Federal+
+++Federal++Na=onal+defense+ +++Federal+Nondefense+
++State+and+local+
Receipts+Versus+Expenditures+
0+
5+
10+
15+
20+
25+
30+1948+
1951+
1954+
1957+
1960+
1963+
1966+
1969+
1972+
1975+
1978+
1981+
1984+
1987+
1990+
1993+
1996+
1999+
2002+
2005+
2008+
%%GDP%
++++Current+receipts+ ++++Current+expenditures+
Government+Receipts+
0+
5+
10+
15+
20+
25+
1948+
1951+
1954+
1957+
1960+
1963+
1966+
1969+
1972+
1975+
1978+
1981+
1984+
1987+
1990+
1993+
1996+
1999+
2002+
2005+
2008+
%%GDP%
++++Current+receipts+ Current+tax+receipts+
++Personal+current+taxes+ ++Taxes+on+produc=on+and+imports+
++Taxes+on+corporate+income+
Expenditures+
0+
5+
10+
15+
20+
25+
30+
1948+
1951+
1954+
1957+
1960+
1963+
1966+
1969+
1972+
1975+
1978+
1981+
1984+
1987+
1990+
1993+
1996+
1999+
2002+
2005+
2008+
2011+
%%of%G
DP%
++++Current+expenditures+ Consump=on+expenditures+
Current+transfer+payments+ ++Government+social+benefits+
Macroeconomics - Barro Chapter 12 13
Data+on+Government+Expenditure+
DEBTO+TO+GDP+RATIO+
Macroeconomics - Barro Chapter 12 14
TOP+RATES+
Macroeconomics - Barro Chapter 13 15
Summary%of%Federal%Income%Tax%Data,%2009%
Number of Returns with Positive AGI
AGI ($ millions)
Income Taxes Paid ($
millions)
Group's Share of Total AGI
Group's Share of Income Taxes
Income Split Point
Average Tax Rate
All Taxpayers 137,982,203 $7,825,389 $865,863 100.0% 100.0%
- 11.06%"
Top 1% 1,379,822 $1,324,572 $318,043 16.9% 36.7% $343,927.00 24.01%"
1-5% 5,519,288 $1,157,918 $189,864 14.8%
22.0% 16.40%
Top 5% 6,899,110 $2,482,490 $507,907 31.7% 58.7% $154,643.00 20.46%"
5-10% 6,899,110
$897,241 $102,249 11.5%
11.8% 11.40%
Top 10% 13,798,220 $3,379,731 $610,156 43.2% 70.5% $112,124.00 18.05%"
10-25% 20,697,331 $1,770,140 $145,747
22.6% 17.0% 8.23%
Top 25% 34,495,551 $5,149,871 $755,903 65.8% 87.3% $66,193.00 14.68%"
25-50% 34,495,551 $1,620,303 $90,449
20.7% 11.0% 5.58%
Top 50% 68,991,102 $6,770,174 $846,352 86.5% 97.7% > $32,396 12.50%"Botto
m 50% 68,991,102" $1,055,215" $19,511" 13.5% 2.3% < $32,396 1.85%"
The+BoEom+40%+
• MAKE+MONEY+FROM+FEDERAL+INCOME+TAXES+
Z+meaning+they+get+more+money+in+tax+credits+
than+they+would+otherwise+owe+in+taxes.+
Macroeconomics - Barro Chapter 13 17
The+One+Percent:+Total+Income+Tax+Shares,+1980Z2009+
(Percent+of+federal+income+tax+paid+by+each+group)++
0.00%+
10.00%+
20.00%+
30.00%+
40.00%+
50.00%+
60.00%+
70.00%+
80.00%+
90.00%+
100.00%+
1980+
1981+
1982+
1983+
1984+
1985+
1986+
1987+
1988+
1989+
1990+
1991+
1992+
1993+
1994+
1995+
1996+
1997+
1998+
1999+
2000+
2001+
2002+
2003+
2004+
2005+
2006+
2007+
2008+
2009+
Top+1%+ Top+5%+ Between+5%+&+10%+
Top+10%+ Between+10%+&+25%+ Top+25%+
Between+25%+&+50%+ Top+50%+ BoEom+50%+
Country+Comparisons+
Macroeconomics - Barro Chapter 13 19
How+it+Works:+Aggregate+Supply+and+
Demand+
.+P+
Y+
AD=Y=C+I+G+
SRAS+
LRAS=Y=AF(K,L,H,R)+
Y*+
EXPANSIONARY+FISCAL+POLICY+
• Increase+in+G+• Income+tax+cuts+
• Corporate+tax+cuts+
Increase+in+Government+Spending:+ShortZrun+
effects+
• ↑+AD+to+AD’+
• ↑+GDP+
• ↑+P+
• ↑+in+the+nominal+value+of+transac=ons/+purchases+
• ↑+money+demand+
• ↑+price+of+money+(interest+rate)++
• ↑+cost+of+borrowing+for+businesses++
• ↓+I+
• G+“crowds+out”+private+investment+(the+“crowding%out%effect”)+
• AD’+↓+to+AD”++
Government+Spending+and+Crowding+
Out:+Originally+in+Recession+(E)+
.+P+
Y+
AD=C+I+G+
SRAS+LRAS+
Y*+
E+
F+
G+
H+
Increase+in+Government+Spending:+LongZrun+
effects+
• ↓+I+→+the+economy+is+building+a+smaller+
capital+stock+(K)+
• ↓+produc=ve+capacity+for+the+economy+as+a+
whole+
• Growth+prospects+are+hurt+• Shix+in+of+the+en=re+AS+curve++• ↑+P++
Government+Spending+and+Crowding+
Out:+Originally+in+Recession+(E)+
P+
Y+
AD+
SRAS+LRAS+
Y*+
E+
F+
G+
H+
Increase+in+G:+Effects+on+Deficits+and+Debt+
• Budget+deficit+=+(GZT)++
• ↑+G+→+↑+government+deficits+/+↓+surpluses+
• ↑+borrowing+→+↑+government+debt+
Historically+Thought:+Effects+of+an+
Income+Tax+Cut+
• ↑+disposable+income+(DI)+
• ↑+consump=on++
• ↑+AD+
• ↑+GDP+
• ↑+P+
• “crowdingZout”+effect++• Deficit+and+debt+s=ll+increase+• Same+effects+in+the+long+run+
• Same+effects+as+before+in+an+open+economy+
Effects+of+a+Corporate+Tax+Cut+
• They+increase+investment+spending+(I)++
• ↑+AD++
• ↑+GDP++
• ↑+P++
• No+crowding+out+effect+• The+deficit+and+debt+s=ll+increase+as+in+the+previous+case+• The+twin+deficit+problem+s=ll+follows+
• In+the+long+run,+↑+K+→+↑+produc=ve+capacity+→+beEer+
growth+prospects+→+↑AS+
• P+might+end+up+falling+in+the+long+run+
Corporate+Tax+Cut+
.+P+
Y+
AD+
SRAS+LRAS+
Y*+
E+
F+
G+
The+Reagan+Plan+
• What%Was%Happening%at%the%Time?%Beginning%of%1981:+– Huge+budget+deficits+– DoubleZdigit+infla=on+rates+– 20%+interest+rates+– Very+high+unemployment+rate,+close+to+7%+
– Real+wages+falling+– Federal+taxes+for+the+average+family+increasing+by+more+than+50%+
– Na=onal+debt+skyrocke=ng+– Expected+to+add+even+more+to+it+over+that+year+
The+Proposed+Reagan+Plan+
Goals:+– Lower+government+spending+and+cut+taxes+
– Eliminate+unnecessary+regula=ons+
– Keep+infla=on+under+control+– Ensure+economic+growth+and+lower+unemployment%
• Proposal:+– Lower+some+subsidies+to+local+governments+
– Lower+subsidies+to+profitable+business+and+industry+– Reduce+the+size+of+subsidized+lending+programs+
– Provide+incen=ves+to+increased+produc=vity+• 10%+income+tax+cut+every+year+for+3+years+for+everyone+
• QuesMon%for%you:+– Won’t+this+be+infla=onary?++YES+/+NO++++++Why?+
The+Idea+Behind+SupplyZSide+Tax+Cuts+
• SupplyZside+economics++=+idea+that+↓+personal%or%corporate%taxes++⇒++↑+AS++⇒+
– ↑+GDP++– ↓+price+level+
• So+Reagonomics+says+cuzng+individual+taxes+
does+not+work+the+same+way+as+government+
spending.+
• Reagan+
Goal+Of+Supply+Side+Economics+
.+P+
Y+
AD+
SRAS+LRAS+
Y*+
E+
F+
A+Successful+Supply+Side+Tax+Cut+
.+P+
Y+
AD+
SRAS+LRAS+
Y*+
E+
F+
G+
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