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Chapter 7 Fiscal Policy. These slides supplement the textbook, but should not replace reading the textbook. Who were the Classical Economists?. A group of the 18 th and 19 th centuries, including Adam Smith known as the father of modern day economics.
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Chapter 7Fiscal Policy These slides supplement the textbook, but should not replace reading the textbook
Who were theClassical Economists? • A group of the 18th and 19th centuries, including Adam Smith known as the father of modern day economics
What did Adam Smith and the Classical Economists believe? • The economy was always tending toward a full employment equilibrium and stable prices
What doeslaissez-faire mean? • Leave well enough alone, let the economy correct problems itself
What happened in the Depression of 1921? • Even though it was serious the government practiced laissez-faire and the economy recovered in a short period of time
What were policies of President Herbert Hoover in the early 1930s to combat the depression? • public works projects • raised taxes • loans to failing firms • relief programs
What were policies of President Franklin Roosevelt in 1933 to combat the depression? • public works projects and social welfare programs • raised taxes and wages • loans to failing firms • relief programs
According to Robert Reich, an American political economist and professor, what was the result of these government programs? • These programs helped save American capitalism
According to Thomas Woods author of Meltdown, what was the result of these government programs? • These programs prevented the economy from seeking its equilibrium of full employment and prolonged the depression
What is a fiscal policy? • The manipulation of government purchases, transfer payments, taxes, and borrowing in order to positively influence the economy
How did Keynes influence fiscal policies? • He argued that fiscal policies may be necessary to bring about full employment
How did World War II affect fiscal policies? • It showed that a government stimulus package can work
What is theEmployment Act of 1946? • Its main purpose was to lay the responsibility of economic stability of inflation and unemployment onto the federal government
What are the four phases of the business cycle? • trough • recovery • peak • recession
What are the 3 pillars ofKeynesian Economics? • Liquidity trap • Balanced budget multiplier • Paradox of thrift
What is a liquidity trap? • A lack of borrowing keeps money bottled up in savings institutions
What is the Keynesian solution to a liquidity trap? • Government borrows the money that consumers and business do not borrow
What is the Balanced Budget Multiplier? • When the government taxes and spends the money there is a multiple effect because of no savings
What is the Paradox of Thrift? • The more people save, the less will be demand, which leads to slow growth
What does crowding out mean? • During periods of full employment the government can borrow money that otherwise would be spent or invested
How does the government borrow money? • It sells bonds (securities) to the Fed or in the Open Market
What is the current national debt? • Just over $18.5 trillion • http://www.usdebtclock.org/
What does monetizing the debt (quantitative easing) mean? • The federal government sells bonds (securities) to the Fed and the Fed creates the money to buy the bonds
What can monetizing the debt lead to? • A fall in the value of the dollar and inflation
What is a discretionary fiscal policy? • Government policies that require ongoing decisions by policy makers
What are some examples of fiscal policies? • Government purchases • Transfer payments • Taxes
What are automatic stabilizers? • Structural features of government spending and taxation smooth out fluctuations in booms and busts
What are some examples of automatic stabilizers? • Unemployment payments • Welfare • Other govt. programs
What is the point of Keynesian Economics? • The economy could be stuck at equilibrium below the potential output for a prolonged period of time
What is an expansionary fiscal policy? • An increase in government purchases, decrease in net taxes, or some combination of the two aimed at increasing aggregate demand
When would the government use expansionary fiscal policies? • To stimulate the economy when unemployment is greater than the natural rate
What is a contractionary fiscal policy? • A decrease in government purchases, increase in net taxes, or some combination of the two aimed at reducing aggregate demand
When would the government use contractionary fiscal policies? • To slow down the economy when inflation is more than desired
What is the typical Keynesian policy during recessions? • To use discretionary fiscal policies to stimulate the economy to a full employment equilibrium
What is the multiplier? • Any change in the level of spending has a multiple effect on GDP
What is the accelerator? • Any increase in spending can lead to an increase in secondary spending, for example, a new highway may lead to more restaurants, hotels, and gas stations
When does the accelerator have most impact on spending? • During periods of full employment
How did World War II affect fiscal policies? • It showed that a government stimulus package can work
What is MPC? • The marginal propensity to consume (MPC) is a measure of how much consumers will spend out of any addition to their income
What is MPS? • The marginal propensity to save (MPS) is a measure of how much consumers will save out of any addition to their income
If MPC is ¾, what is MPS? • MPS would be ¼ because MPC + MPS = 1
What is the value of the multiplier? • 1 / MPS
If MPC is ¾, what is the value of the multiplier? • 1 / ¼ = 4
$100.00 • $75.00 • $56.25 • $42.19 • $31.64 • ... • original spent • total money $400.00
What effect does an increase in demand have on prices and output? • The more steeply sloped the supply curve the greater impact on prices and the less impact on employment
Slightly sloped Supply Curve • Price • Level • SRAS • AD* • AD Real GDP
Steeply sloped Supply Curve • Price • Level • SRAS • AD* • AD Real GDP
How effective are fiscal policies? • Automatic stabilizers are more effective than are discretionary fiscal policies
Should we rely on automatic stabilizers? • The stronger and more effective the automatic stabilizers are, the less need there is for discretionary fiscal policies
How effective were fiscal policies during the stagflation of the 1970’s? • Whatever we did to fight one problem we made the other problem worse