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FISCAL POLICY

FISCAL POLICY. Thanksgiving. FISCAL POLICY. International Finance I. MONETARY POLICY. International Finance II. The Uncertain Multiplier. And Wrap Up. Fiscal policy. Focus Spending distinguish between purchases and spending or outlays or expenditures Tax revenues

matthew-schultz
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FISCAL POLICY

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  1. FISCAL POLICY

  2. Thanksgiving FISCAL POLICY International Finance I MONETARY POLICY International Finance II The Uncertain Multiplier And Wrap Up

  3. Fiscal policy • Focus • Spending • distinguish between purchases and spending or outlays or expenditures • Tax revenues • distinguish between tax rates and tax revenues • let t = tax rate, Y = income, • then tax revenue is T = tY • Government debt • Today’s topics: effect of deficit, debt, countercyclical policy, structural deficit, automatic stabilizers, rules versus discretion

  4. 29_02 President submits Congress debates, Supplementary budget or Fiscal year is over; budget to Congress modifies, and changes in economy may spending and taxes in early February. passes budget. affect actual spending. are tabulated. Fiscal year 2000 Jan. 1, 1999 Apr. 1 July 1 Oct. 1 Jan. 1, 2000 Apr. 1 July 1 Oct. 1 Jan. 1, 2001

  5. Federal budget summary (billions of dollars)Fiscal year 1998 versus 1995

  6. Deficit versus debt • When the government runs a deficit, it increases its debt • When the government runs a surplus, it reduces its debt • surplus (‘98) = debt (end ‘97) - debt (end ‘98) • 70 = 3771.1 - 3701.1 • Government borrows by issuing bonds • and retires these bonds when in has a surplus

  7. A graph of the deficit and the debt BILLIONS 29_03 OF DOLLARS Debt 3,500 3,000 2,500 2,000 1,500 1,000 500 Deficit 0 -500 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995

  8. Debt as a share of GDP • Debt/GDP can stay constant or even fall when there is a budget deficit • Example • 5% growth of GDP • then ratio stays constant if • Debt/GDP = Debt(1.05)/GDP(1.05) • thus $3.7 trillion times (.05) = $185 billion deficit • Debt/GDP ratio falls with balanced budget

  9. Ratio just starting to decline 

  10. Long run effect of deficits or surpluses • The long run effect of a lower deficit or higher surplus are those of a lower the share of G in GDP---use SAM • real interest rate lower • I/Y higher, leading to higher potential growth • Short run negative effects can be mitigated by being gradual, being credible, and letting Fed join in (but this is an old issue, now...

  11. The question is how to “use” the “projected” surplus • Recent shift from deficit to surplus • Leave it? Cut taxes? Increase spending? • The social security problem • As baby boom generation retires, benefits will grow relative to payroll tax revenues • Will need to reduce benefits or increase taxes • Some suggest privatizing part of social security

  12. Countercyclical fiscal policy • Argues that increasing government spending or reducing taxes during a recession would mitigate the recession • Suggested by Keynes in 1930s (Keynesian policy) • Rationale now for “fiscal stimulus” package in Japan • Discretionary versus automatic

  13. ADI with increase in Old ADI Old ADI ADI with decrease in Use of countercyclical fiscal policy (G) to bring the economy back to potential Potential GDP INFLATION 29_05 PA government purchases REAL GDP Potential GDP INFLATION PA government purchases REAL GDP

  14. ADI with Old ADI Old ADI ADI with tax Use of countercyclical fiscal policy (taxes) to bring economy back to potential Potential GDP 29_06 INFLATION PA tax cut REAL GDP Potential GDP INFLATION PA increase REAL GDP

  15. Old ADI ADI with Case of good timing in using fiscal policy to hasten the return of real GDP back to potential GDP INFLATION Potential GDP 29_08 Path of economy without a fiscal stimulus Path of economy with a fiscal stimulus PA ADI without stimulus stimulus REAL GDP

  16. Effect of fiscal policy on the path of real GDP: good and bad timing

  17. Effect of the economy on the budget deficit • Budget deficit is cyclical • Deficit rises in recessions • Deficit falls during recoveries and expansions • To see the reason look at tax revenues and expenditures

  18. Government tax revenues depend on the state of the economy • when real GDP grows more rapidly, tax revenues rise faster • more people working, higher incomes • people move into higher tax brackets • when real GDP grows more slowly, tax revenues rise less rapidly • fewer people working, lower incomes • people may move into lower tax brackets

  19. Expenditures also depend on the economy • When real GDP grows less rapidly or falls, as in a recession, expenditures grow more rapidly • unemployment compensation rises • welfare payments go up • more people retire, increasing social security payments • When real GDP grows more rapidly, as in a recovery, expenditures grow less rapidly

  20. Net effect of real GDP on deficit • deficit = government spending - tax revenue • thus in a recession the deficit will rise, and in a recovery the deficit will fall • Y implies D • government spending  and tax revenues  • Y  implies D • government spending  and tax revenues  • Explains why “rosy scenarios” make the deficit look smaller

  21. A NEW GRAPH to show the effect of real GDP on the deficit

  22. The structural deficit • The structural deficit is the deficit that would exist if real GDP = potential GDP • Also called full employment deficit • Purpose is to take out (control for) the effects of economic fluctuations in real GDP on the deficit • Changing structural deficit requires • change in tax laws, size of government,...

  23. Graphical illustration of the structural deficit

  24. Automatic stabilizers • The tendency for tax revenues to fall and government spending to rise in recessions can have a stabilizing effect on the economy • the changes offset decline in demand during recession (as with countercyclical policies) • these changes are “automatic” • occur without executive or legal action • hence fewer lags, timing is better, overall effects can be very large

  25. Automatic changes in revenues and expenditures due to recession (FY 1991) BILLIONS 29_01 OF DOLLARS 1,400 1,324 1,233 1,170 1,200 1,054 1,000 800 600 400 270 200 63 0 Proposed Actual Proposed Actual Proposed Actual Tax Revenue Expenditures Deficit

  26. Rules versus discretion debate in fiscal policy • Problems with discretion are mainly lags • recognition, implementation, impact • Rules  automatic stabilizers • Johnson surcharge (1968) • Bush stimulus package (1992) • Clinton stimulus package (1993) • Kennedy tax cut (1964) • Reagan tax cut (1981-82)

  27. END OF LECTURE

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