Legislative Mandate Fiscal Policy and the ADAS Model

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 12 CHAPTER FISCAL POLICY Key Terms Previous Slide End Show 12 - 1 Next Slide Copyright Mc. Graw-Hill/Irwin, 2005

LEGISLATIVE MANDATES 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 Previous Slide End Show 12 - 2 Next Slide Employment Act of 1946 Council of Economic Advisors (CEA) Joint Economic Committee (JEC) Copyright Mc. Graw-Hill/Irwin, 2005

FISCAL POLICY AND THE AD-AS MODEL 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 Previous Slide End Show 12 - 3 Next Slide Two Options • Discretionary Fiscal Policy • Non-Discretionary Fiscal Policy Expansionary Fiscal Policy To Reduce Unemployment… • Increase Government Spending • Tax Reductions • Combinations of the Two Copyright Mc. Graw-Hill/Irwin, 2005

EXPANSIONARY FISCAL POLICY the multiplier at work Legislative Mandate $5 billion initial increase in spending Fiscal Policy and the AD-AS Model Expansionary and Contractionary Fiscal Policy Built-In Stability Evaluating Fiscal Policy Problems, Criticisms, and Complications Fiscal Policy in the Open Economy Price level Financing of Deficits and Disposing of Surpluses AS Full $20 billion increase in aggregate demand P 1 Forecasting the Future Key Terms Previous Slide End Show 12 - 4 Next Slide AD 2 $490 AD 1 $510 Real GDP (billions) Copyright Mc. Graw-Hill/Irwin, 2005

FISCAL POLICY AND THE AD-AS MODEL 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 Previous Slide End Show 12 - 5 Next Slide Contractionary Fiscal Policy To Reduce Inflation… • Decrease Government Spending • Tax Increases • Combinations of the Two Copyright Mc. Graw-Hill/Irwin, 2005

CONTRACTIONARY FISCAL POLICY the multiplier at work Legislative Mandate $5 billion initial decrease in spending Fiscal Policy and the AD-AS Model Expansionary and Contractionary Fiscal Policy Built-In Stability Evaluating Fiscal Policy Problems, Criticisms, and Complications Fiscal Policy in the Open Economy Price level Financing of Deficits and Disposing of Surpluses AS P 2 Full $20 billion decrease in aggregate demand P 1 Forecasting the Future Key Terms AD 3 Previous Slide End Show 12 - 6 Next Slide AD 4 $510 $522 Real GDP (billions) Copyright Mc. Graw-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 Previous Slide End Show 12 - 7 Next Slide FINANCING OF DEFICITS AND DISPOSING 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? Copyright Mc. Graw-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 Previous Slide End Show 12 - 8 Next Slide BUILT-IN STABILITY Net tax revenues vary directly with GDP Transfer payments behave the opposite way as tax collections Automatic or Built-In Stabilizers Economic Importance Copyright Mc. Graw-Hill/Irwin, 2005

BUILT-IN STABILITY Legislative Mandate 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 Previous Slide End Show 12 - 9 Next Slide Government Expenditures, G, and Tax Revenues, T Fiscal Policy and the AD-AS Model T Surplus G Deficit GDP 1 GDP 2 GDP 3 Real Domestic Output, GDP Copyright Mc. Graw-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 Previous Slide End Show 12 - 10 Next Slide 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. Copyright Mc. Graw-Hill/Irwin, 2005

FULL-EMPLOYMENT DEFICITS Legislative Mandate 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 Previous Slide End Show 12 - 11 Next Slide Government Expenditures, G, and Tax Revenues, T (billions) Fiscal Policy and the AD-AS Model $500 475 450 425 No Change in Fiscal Policy b a c GDP 2 GDP 1 (Year 2) (Year 1) Real Domestic Output, GDP Copyright Mc. Graw-Hill/Irwin, 2005 T 1 G

FULL-EMPLOYMENT DEFICITS Legislative Mandate 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 Previous Slide End Show 12 - 12 Next Slide Government Expenditures, G, and Tax Revenues, T (billions) Fiscal Policy and the AD-AS Model $500 475 450 425 Discretionary Fiscal Policy Tax Decrease e f d h g GDP 4 GDP 3 Year 4 Year 3 Real Domestic Output, GDP Copyright Mc. Graw-Hill/Irwin, 2005 T 1 T 2 G

EVALUATING FISCAL POLICY 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 Previous Slide End Show 12 - 13 Next Slide Full-Employment Budget Cyclical Deficit Recent U. S. Deficits & Surpluses Year Actual Deficit or Surplus Full-Employment Deficit or Surplus 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 -3. 9% -4. 5% -4. 7% -3. 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% Copyright Mc. Graw-Hill/Irwin, 2005

GLOBAL PERSPECTIVE 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 Previous Slide End Show 12 - 14 Next Slide BUDGET DEFICITS OR SURPLUSES AS A PERCENTAGE OF GDP, 2002 -6 -4 -2 0 2 4 Italy Sweden Canada United Kingdom France United States Ireland Norway Japan Source: Organization for Economic Development and Cooperation Copyright Mc. Graw-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 Previous Slide End Show 12 - 15 Next Slide 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 Copyright Mc. Graw-Hill/Irwin, 2005

Legislative Mandate FISCAL POLICY, AGGREGATE SUPPLY AND INFLATION Fiscal Policy and the AD-AS Model Expansionary and Contractionary Fiscal Policy Built-In Stability Evaluating Fiscal Policy Problems, Criticisms, and Complications Fiscal Policy in the Open Economy Price level Financing of Deficits and Disposing of Surpluses AS Fiscal Policy: No Complications P 1 Forecasting the Future Key Terms Previous Slide End Show 12 - 16 Next Slide AD 1 $490 AD 2 $510 Real GDP (billions) Copyright Mc. Graw-Hill/Irwin, 2005

Legislative Mandate FISCAL POLICY, AGGREGATE SUPPLY AND INFLATION Fiscal Policy and the AD-AS Model Expansionary and Contractionary Fiscal Policy Built-In Stability Evaluating Fiscal Policy Problems, Criticisms, and Complications Fiscal Policy in the Open Economy Price level Financing of Deficits and Disposing of Surpluses AS Fiscal Policy: Showing Crowding-out Effect or Net Export Effect P 1 Forecasting the Future Key Terms Previous Slide End Show 12 - 17 Next Slide AD 1 AD’ 2 AD 2 $490 $510 $504 Real GDP (billions) Copyright Mc. Graw-Hill/Irwin, 2005

Legislative Mandate FISCAL POLICY IN THE OPEN ECONOMY Fiscal Policy and the AD-AS Model Expansionary and Contractionary Fiscal Policy Financing of Deficits and Disposing of Surpluses Shocks Originating from Abroad Built-In Stability Evaluating Fiscal Policy Problems, Criticisms, and Complications Net Export Effect Fiscal Policy in the Open Economy Forecasting the Future Key Terms Previous Slide End Show 12 - 18 Next Slide Copyright Mc. Graw-Hill/Irwin, 2005

Forecasting the Future 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 Previous Slide End Show 12 - 19 Next Slide The 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 Copyright Mc. Graw-Hill/Irwin, 2005

fiscal policy progressive tax system Employment Act of 1946 proportional tax system Council of Economic Advisers (CEA) regressive tax system expansionary fiscal policy cyclical deficit budget deficit political business cycle contractionary fiscal policy crowding-out effect budget surplus net export effect full-employment budget built-in stabilizer Copyright Mc. Graw-Hill/Irwin, Inc. , 2005 BACK END

Legislative Mandate Chapter 13 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 Previous Slide End Show 12 - 21 Next Slide Money and Banking Next. . . Copyright Mc. Graw-Hill/Irwin, 2005