Fiscal Policy Wrapup Multiplier Effect Policy Lag Automatic
- Slides: 8
Fiscal Policy Wrap-up Multiplier Effect, Policy Lag & Automatic Stabilizers
Policy Lags • Fiscal policy has long “policy lags” – Taxes take time to cut – Spending takes time to occur Price Level LRAS 1 AD 1 Real GDP SRAS 1
End result of Fiscal Policy? • • • Multiplier Effect Crowding Out Net Export Effect Automatic Stabilizers State & Local Tax Laws All make predicting the final effect of FISCAL POLICY Difficult! Price Level LRAS 1 SRAS 1 AD 2 AD 1 Real GDP
The CONFLICT between 2 -theories: Multiplier Effect Crowding Out When Government Spending increases: → Multiplier argues for a larger increase in real GDP (AD) → Crowding out argues for a smaller increase in AD (real GDP) We will ASSUME the multiplier always overpowers crowding out!
Net Export Effect Gov’t Borrows $ Real Interest Rates Rise Currency Appreciates $ Export Less Explanation: • The US $ appreciates (worth more vs other currencies) • Goods become more expensive foreigners • They buy less (NX ↓)
Automatic Stabilizers • Considered anything which automatically: – Increases deficit during recessionary periods – Increases surplus during inflationary periods During Recessions During Booms Collect less taxes Pay more unemployment & welfare benefits Collect more taxes (progressive tax system) Pay less unemployment & welfare benefits
State & Local Taxes • States & Local Governments are usually required to balance budget • Therefore, they may raise taxes when federal government cuts taxes – During recessions! – Offsets some of expansionary fiscal policy
Practice Free Response Price Level LRAS 1 AD 1 Real GDP SRAS 1
