1. Chapter 11 and 15

2.  The use of government taxes and spending to manipulate the economy. Chapter 11 2

3.  Discretionary Fiscal Policy  Non-Discretionary Fiscal Policy Chapter 11 3

4.  Deliberate manipulation of taxes & government spending to:  Alter GDP  Change employment levels  Control inflation  Stimulate growth Chapter 11 4

5.  Expansionary fiscal policy  Contractionary fiscal policy Chapter 11 5

6.  Try to increase growth of the economy  During recession Chapter 11 6

7.  Increase Government spending  Reduce Taxes  Do both Chapter 11 7

8.  Higher real GDP  Higher employment  Higher inflation  Higher government budget deficit:  Income same, spending more  Income less, spending the same  Income less, spending more Chapter 11 8

9.  Try to reduce growth of the economy  Use when Cost-Push inflation is high Chapter 11 9

10.  Decrease Government spending  Increase Taxes  Do both Chapter 11 10

11.  Lower real GDP  Lower employment  Lower prices  this is slow because prices are “sticky”  Lower government budget deficit Chapter 11 11

12.  If you spend more than you make, you can:  Increase income ▪ Second job, better job  Lower spending ▪ Less fun stuff  Borrow ▪ Bank, friends Chapter 11 12

13.  If The government spends more than it makes, it has the same options:  Increase income ▪ Raise taxes  Lower Spending  Borrow ▪ Sell bonds  Plus:  Money Creation ▪ Print more money Chapter 11 13

14. 1. Borrowing  The government is competing with individuals & businesses for the scarce “loanable funds”  When the government borrows, there is less for us to borrow – “Crowding Out”  Crowding out pushes interest rates higher ▪ Rates are higher, businesses & households are borrowing & investing less. ▪ This is contrary to growth the government is trying to get Chapter 11 14

15. 2. Money Creation  As they print more money the currency loses value.  Prices are now higher  This makes exporting tougher & importing easier ▪ American products are more expensive ▪ Foreign products are now comparatively cheaper ▪ This costs jobs in the U.S. Chapter 11 15

16.  The increased government borrowing lead to higher interest rates.  We are competing with the government to borrow the limited available funds.  The increased government borrowing lead to higher prices.  Deficit borrowing means the government is buying more than it “should”. This increases demand, which increases prices. Chapter 11 16

17. 1. Debt retirement  Get ahead & pay off bills  Puts $ back in the market, which brings: ▪ lower interest rates ▪ higher investment ▪ higher consumption ▪ higher prices 2. Impounding  Holding the extra money  Greater contractionary impact Chapter 11 17

18.  Which is better at stimulating the economy?  Liberals/Democrats:  expand with increased G  contract with increased taxes  Conservatives/Republicans:  expand with lower taxes  contract with lower G Chapter 11 18

19.  Built in (Automatic) Stabilizers  Taxes  Unemployment benefits  Welfare benefits  Interest rates  When economy grows, these grow, which slows the economy Chapter 11 19

20. 1. Stability is only one of the economic goals 2. State & local governments may have balanced budget rules  their actions may go counter to federal actions 3. Crowding out Chapter 11 20

21. 4. Biases  Tax cuts & increased G are politically good.  Tax increases & cutting G is not 5. Political business cycle 6. Offsetting savings  Ricardian Equivalence Chapter 11 21

22.  Recognition lag  Time to recognize the problem  Administrative lag  Time to come up with a plan  Operational lag  Time for the plan to work Chapter 11 22

23. 1. Lower taxes leads to higher C 2. Higher income leads to higher savings  interest rates drop 3. Lower interest leads to more Investment Chapter 11 23

24. 4. Higher income leads to more incentive to work more & better  higher productivity 5. Higher productivity brings higher wages 6. Lower taxes allows companies more freedom to try new things Chapter 11 24

25.  Output will increase a lot.  Incomes after taxes will increase more than prices will  Tax revenue from output increase will be greater than revenue lost from cut Chapter 11 25

26. Chapter 11 26 Price Level Quantity AS AD Real GDP New AS New AD New Real GDP

27.  The increase in output & benefits of additional Investment takes time.  The increase in efficiency may reduce the number of new workers needed to meet the demand Chapter 11 27

28. 1. The benefits of tax cuts take too much time 2. Increase G  AD shifts out immediately 3. Higher G leads to more income for companies  Higher incomes Chapter 11 28

29. 4. Higher corporate incomes will lead to increased tax revenue 5. Companies will hire more people to help meet the demand 6. Newly-hired & Government handout- recipients will increase spending Chapter 11 29

30.  Borrow money & overspend in the short-term to get the economy back on it’s feet  Pay it back when the economy gets healthy Chapter 11 30

31. Chapter 11 31 Price Level Quantity AS AD Real GDP New AS New AD New Real GDP

32.  Government is competing with consumers for goods  Higher prices  Taxes will have to be raised in the future  Government short-term borrowing will increase interest rate, limiting new Investment Chapter 11 32

33.  Old Classicals  AS perfectly vertical ▪ no short term changes ▪ it only shifts out by shocks.  rGDP determined by AS shifts ▪ only prices from AD shifts Chapter 11 33

34. Chapter 11 34 Price Quantity AS AD Real GDP New AS New AD New Real GDP New

35.  New Classicals:  Unexpected price changes can change rGDP in short run  Unexpected changes in AS, money supply, or fiscal policy will change rGDP  Government managing AD will result in: ▪ rGDP change if unexpected ▪ Price changes if expected Chapter 11 35

36. Chapter 11 36 Price Level Quantity AS AD Real GDP New AS New AD New Real GDP

37.  Old Keynesians:  Technology change is so slow that AS was flat, so...  Prices are constant “sticky” so…  Changing Aggregate Expenditures will determine real GDP  Manage economy by managing AD Chapter 11 37

38. Chapter 11 38 Price Level Quantity AS AD Real GDP New AD New Real GDP

39.  New Keynesians  They agreed: AS is sloped upward.  Wages are sticky too, because of wage contracts, efficiency wages, & minimum wages  You can still manage the economy by managing AD Chapter 11 39

40. Chapter 11 40 Price Level Quantity AS AD Real GDP New AS New AD New Real GDP

41.  New Keynesians say changing money supply will change investment  Monetarists say consumption will also change  Both Investment & consumption changes will be short-run  In long-run rGDP will be at the natural rate of unemployment Chapter 11 41

42.  The economy tends toward equilibrium, so government intervention isn’t necessary  Rules should be set & followed to let the economy solve itself Chapter 11 42