McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. FISCAL POLICY PROBLEMS AND ALTERNATIVES FISCAL POLICY PROBLEMS AND ALTERNATIVES Chapter 14

McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved What is the Current Situation? Problem  Getting reliable numbers on the economy takes time.  We may be in a recession and not know it. Solutions  Econometric models  Leading indicators

McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved What is the Target? What is potential output? How close/far is the economy from potential output?

McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved How is Policy Implemented? Agreeing what to do—Delay #1 Getting it done—Delay #2 Waiting for it to work—Delay #3

McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. Will There be Crowding Out? Government borrows to pay for its spending. The increased demand for loans drives Interest rates up. Higher interest rates reduce investment Demand The spending multiplier effect is reduced 14-5

McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved How Will the Size of the Debt Change Over time? It’s easier to increasing spending and decrease taxes than the reverse Result—lots of deficits and few surpluses

McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved Can There be Conflicts With Other Goals? Getting to potential output may be one of several government goals  Reducing taxes  Reducing the trade deficit  Achieving energy independence  Fixing health care and social security U.S. goals may be in conflict with those of other countries

McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved Automatic Stabilizers Policies that implement fiscal policy without any new government action. Examples  welfare payments  unemployment insurance  Progressive income taxes

McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved Decrease in Fluctuations in the Economy

McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved Automatic Destabilizers State constitutions mandate balanced budgets  During recessions states cut spending and raise taxes.  During expansions states increase spending and cut taxes. State “Rainy Day” Funds are a possible solution