Chapter 21 Fiscal policy and foreign trade David

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Chapter 21 Fiscal policy and foreign trade David Begg, Stanley Fischer and Rudiger Dornbusch,

Chapter 21 Fiscal policy and foreign trade David Begg, Stanley Fischer and Rudiger Dornbusch, Economics, 9 th Edition, Mc. Graw-Hill, 2008 Power. Point presentation by Alex Tackie and Damian Ward ©The Mc. Graw-Hill Companies, 2008

Some key terms • Fiscal policy – the government’s decisions about spending and taxes

Some key terms • Fiscal policy – the government’s decisions about spending and taxes • Stabilisation policy – government actions to try to keep output close to its potential level • Budget deficit – the excess of government outlays over government receipts • National debt – the stock of outstanding government debt ©The Mc. Graw-Hill Companies, 2008

Government in the income-expenditure model • Direct taxes – affect the slope of the

Government in the income-expenditure model • Direct taxes – affect the slope of the consumption function – and hence the slope of the AD schedule. • Government expenditure affects the position of the AD schedule. ©The Mc. Graw-Hill Companies, 2008

Government in the income-expenditure model • AD=C+I+G • Assume I and G is independent

Government in the income-expenditure model • AD=C+I+G • Assume I and G is independent of Y. • Transfer payment affects C or I and not included in G. ©The Mc. Graw-Hill Companies, 2008

Government in the income-expenditure model • Transfer payment are added to income and direct

Government in the income-expenditure model • Transfer payment are added to income and direct taxes are subtracted from it: • Net taxes=t*Y-B • Disposable income (YD) = (1 -t)*Y+B ©The Mc. Graw-Hill Companies, 2008

Government in the income-expenditure model • Let’s assume autonomous consumption and transfer payments is

Government in the income-expenditure model • Let’s assume autonomous consumption and transfer payments is 0 and mpc is 0. 9 • When Y increases by 1, then consumption will increase by 0. 9*(1 t). • MPC after tax (MPC’)=MPC*(1 -t). ©The Mc. Graw-Hill Companies, 2008

Fiscal policy? Aggregate demand 45 o line AD 1 AD 0 This seems to

Fiscal policy? Aggregate demand 45 o line AD 1 AD 0 This seems to suggest that the government could influence aggregate output in the economy by raising AD from AD 0 to AD 1, thus raising equilibrium output from Y 0 to Y 1. Y 0 Y 1 Income, output But this ignores some important issues – prices, interest rates, and the need to fund the government spending. ©The Mc. Graw-Hill Companies, 2008

8 Borç Verme Sermaye Transferleri Sermaye Giderleri Cari Transferler Faiz Harcamaları Mal ve Hizmet

8 Borç Verme Sermaye Transferleri Sermaye Giderleri Cari Transferler Faiz Harcamaları Mal ve Hizmet Alımları Sosyal Güv. Kur. Devlet Primi Personel Harcamaları Government Spending in Turkey (2005, 2010) (Millions TL) 120000 100000 80000 60000 40000 2005 0 2010 ©The Mc. Graw-Hill Companies, 2008

Sosyal Güvenlik ve Sosyal Yardım Hizmetleri Eğitim Hizmetleri Dinlenme, Kültür ve Din Hizmetleri Sağlık

Sosyal Güvenlik ve Sosyal Yardım Hizmetleri Eğitim Hizmetleri Dinlenme, Kültür ve Din Hizmetleri Sağlık Hizmetleri İskan ve Toplum Refahı Hizmetleri Çevre Koruma Hizmetleri Ekonomik İşler ve Hizmetler Kamu Düzeni ve Güvenlik Hizmetleri Savunma Hizmetleri Genel Kamu Hizmetleri The Government Spending in Turkey (%) (2011) 45 40 35 30 25 20 15 10 5 0 ©The Mc. Graw-Hill Companies, 2008

10 ©The Mc. Graw-Hill Companies, 2008

10 ©The Mc. Graw-Hill Companies, 2008

11 ©The Mc. Graw-Hill Companies, 2008

11 ©The Mc. Graw-Hill Companies, 2008

The Debt in Turkey (Millions of dolars) (2002 -2011) 250000 200000 150000 Kamu Sektörü

The Debt in Turkey (Millions of dolars) (2002 -2011) 250000 200000 150000 Kamu Sektörü Özel Sektör 100000 50000 0 2002 2003 2004 2005 2006 2007 2008 2009 12 2010 2011 ©The Mc. Graw-Hill Companies, 2008

Kaynak: Hazine Müsteşarlığı 13 ©The Mc. Graw-Hill Companies, 2008

Kaynak: Hazine Müsteşarlığı 13 ©The Mc. Graw-Hill Companies, 2008

Kaynak: Hazine Müsteşarlığı 14 ©The Mc. Graw-Hill Companies, 2008

Kaynak: Hazine Müsteşarlığı 14 ©The Mc. Graw-Hill Companies, 2008

The government budget If government spending is independent of income, but net taxes depend

The government budget If government spending is independent of income, but net taxes depend on income, then the budget will be in deficit at low levels of income but in surplus at high levels. G, NT The budget deficit equals total government spending minus total tax revenue. NT Balanced budget G Y 0 Income, output The balanced budget multiplier states that an increase in government spending plus an equal increase in taxes leads to higher equilibrium output. ©The Mc. Graw-Hill Companies, 2008

Automatic stabilisers • mechanisms in the economy that reduce the response of GNP to

Automatic stabilisers • mechanisms in the economy that reduce the response of GNP to shocks – for example, in a recession: • payments of unemployment benefits rise • and receipts from VAT and income tax fall ©The Mc. Graw-Hill Companies, 2008

Limits on active fiscal policy Why can’t shocks to aggregate demand immediately be offset

Limits on active fiscal policy Why can’t shocks to aggregate demand immediately be offset by fiscal policy? • Time lags: it takes time – to diagnose the problem – to take action – for the multiplier process to operate • Uncertainty – the size of the multiplier is not known – aggregate demand is always changing • Induced effects on autonomous demand – changes in fiscal policy may induce offsetting effects in other components of aggregate demand ©The Mc. Graw-Hill Companies, 2008

Limits on active fiscal policy (2) Why doesn’t the government expand fiscal policy when

Limits on active fiscal policy (2) Why doesn’t the government expand fiscal policy when unemployment is persistently high? • The budget deficit – concern about inflation if the budget deficit grows • Maybe we’re at full employment! – unemployment may be (at least partly) voluntary ©The Mc. Graw-Hill Companies, 2008

Foreign trade and income determination • Introducing exports (X) & imports (Z) • TRADE

Foreign trade and income determination • Introducing exports (X) & imports (Z) • TRADE BALANCE – the value of net exports (X - Z) • TRADE DEFICIT – when imports exceed exports • TRADE SURPLUS – when exports exceed imports • Equilibrium is now where –Y=C+I+G+X-Z ©The Mc. Graw-Hill Companies, 2008

Assume that exports are independent of income, X, Z Exports, imports and the trade

Assume that exports are independent of income, X, Z Exports, imports and the trade balance but that imports increase with income. At relatively low income, exports exceed imports – there is a trade surplus. Imports Exports Y* Income At higher income levels, there is a trade deficit. There is trade balance at income Y*, but there is no guarantee that this corresponds to full employment. ©The Mc. Graw-Hill Companies, 2008

Foreign trade and the multiplier • The marginal propensity to import – is the

Foreign trade and the multiplier • The marginal propensity to import – is the fraction of additional income that domestic residents wish to spend on additional imports. • The effect of foreign trade is to reduce the size of the multiplier – the higher the value of the marginal propensity to import, the lower the value of the multiplier. – M=1/[1 -(MPC’-MPZ)] ©The Mc. Graw-Hill Companies, 2008