Royal School of Administration Chapter 11: Fiscal Policy in the - PowerPoint PPT Presentation

Royal School of Administration Chapter 11: Fiscal Policy in the Short Run Lectu tured by: y: HE (Dr.) MAM AMNOT Group 9: 1. Chek Rasy 2. Chuop Theot Therith 3. Eath Sovanara 4. Hang Kakdareasey 5. Srun Sreyneang 6. Uon Ratha 1

Learning Objectives: 1. Explain the goals and tools of fiscal policy 2. Distinguish between automatic stabilizers and discretionary fiscal policy and understand how the budget deficit is measured 3. Use the IS/MP model to understand how fiscal policy affects the economy in the short run 4. Use the IS/MP model to explain the challenge to using fiscal policy effectively 2

Objective I: Explain the goals and tools of fiscal policy 3

1. GOAL AND TOOLS OF FISCAL POLICY 1.1 Goal of Fiscal Policy (1) • What is Fiscal Policy? Fiscal Policy refers to changes the federal government makes in taxes, purchases of goods and services, and transfer payments that are intended to achieve macroeconomic policy objective. 4

1.1 Goal of Fiscal Policy (2) • Why government conduct Fiscal Policy?  Goals:  The goal of fiscal policy is to reduce the severity of macroeconomic fluctuation by increasing maximum: 1. employment 2. production 3. and purchasing power especially leaves price stability 5

1.1 Goal of Fiscal Policy (3) • Who conduct this policy?  In US, the Fiscal Policy required an agreement between Congress and President.  Fed government makes many decisions about taxes and spending ,but not all of these decisions are fiscal policy actions because they are not intended to achieve macroeconomic goals. 6

1.2 Fiscal Policy Tools that affect Real GDP (1) • How do the Fed government conduct this policy?  Fiscal policy can affect the economy in the short- run by causing changes in aggregate expenditure . A.E = C + I + G + NX  Government used traditional and new tools of fiscal policy that affect real GDP 7

1.2 Fiscal Policy Tools that affect Real GDP (2) Traditional tools (3): (1) Government Purchase: goods and services  Government purchase goods and services  increase in Government expenditure  increase in aggregate expenditure  increase in real GDP and employment. (2) Taxes:  Change in taxes affects the consumption and investment component of aggregate expenditure. 8

1.2 Fiscal Policy Tools that Affect Real GDP (3) (2) a. Consumption:  A decrease in the tax rate on personal income  an increase in disposable income  an increase in consumption  an increase in AE  an increase in real GDP and employment.  An increase in consumption taxes  an increase in prices of consumption goods  a decrease in consumption  a decrease in aggregate expenditure  a decrease in Real GDP and employment. 9

1.2 Fiscal Policy Tools that Affect Real GDP (4) (2) b. Investment  An increase in cooperate income taxes  a decrease in the after-tax profitability of investment projects  a decrease in aggregate expenditure  a decrease in Real GDP an employment.  A decrease in corporate income taxes  an increase the after-tax profitability of investment projects  increase in aggregate expenditure  a increase in Real GDP 10

1.2 Fiscal Policy Tools that Affect Real GDP (5) (3) Transfer Payment:  An increase in transfer payments  an increase in disposable income  an increase in consumption  an increase in aggregate expenditure  an increase in real GDP and employment. 11

1.2 Fiscal Policy Tools that Affect Real GDP (6) New tool: • In October 2008, to deal with the financial recession, Congress passed the Troubled Asset Relief Program (TARP) to provided the Treasury and Fed with the $700 billion in funding to help market for mortgage-baked securities and other toxic asset in order to provide relief to financial that had trillion of dollars worth if these assets on their balance sheet. • Is TARP a Fiscal Policy? 12

1.3 Type of Fiscal Policy • Expansionary fiscal policy is intended to increase real GDP and employment by increasing aggregate expenditure. It is used during the recession. • Contractionary fiscal policy is intended to reduce increase in aggregate expenditure that seems likely to lead to inflation. It is used during inflation. 13

Objective II: Distinguish between automatic stabilizers and discretionary fiscal policy and understand how the budget deficit is measured 14

2. BUDGET DEFICIT DISCRETIONARY FISCAL POLICY AND AUTOMATIC STABILIZERS 2.1 Discretionary Fiscal Policy and Automatic Stabilizers Discretionary fiscal policy Automatic stabilizers  Government policy that involves  Taxes, transfer payments, or deliberate change in taxes, government expenditures that transfer payments, or government automatically increase or decrease purchase to achieve with business cycle.  Changes occur due to the effect of macroeconomic policy objectives.  Changes occur because the existing law.  Automatic stabilizers help to government decide to change current law to achieve reduce the severity of business macroeconomic policy objective. cycle by reducing the size of multiplier. 15

2.2 Budget Deficits/Surplus (1) • Budget Deficits: The situation in which the government’s expenditure is greater than its tax revenue. • Budget surplus: The situation in which the government’s expenditure is less than its tax revenue. 16

2.2 Budget Deficits/Surplus (2) 17

2.2 Budget Deficits/Surplus (3) • Budget deficit/surplus happen automatically. Economic expansion => (income, output, employment) ↑ ⇒ T ↑ &TR ↓ => Budget deficit ↓ or Budget surplus ↑ • Any particular year, Budget deficit/surplus result from: – Discretionary fiscal policy (cyclically adjusted budget deficit or surplus) – The response of automatic stabilizer Budget deficit= Cyclically adjusted budget deficit + Effect of automatic stabilizers 18

2.2 Budget Deficits/Surplus (4) • Cyclically adjusted budget deficit or surplus: – Measure what the deficit/surplus in the federal government would be if real GDP equaled potential GDP. – Would exist if worker were fully employed. • If Cyclically adjusted budget deficit  Expansionary fiscal policy • If Cyclically adjusted budget surplus  Contractionary fiscal policy 19

2.2 Budget Deficits/Surplus (5) 20

2.2 Budget Deficits/Surplus (6) • The deficit and the debt : Budget deficit  Government sells bond/ securities  gross federal debt held by the public. – If debt becomes very large, the government may have to raise taxes to higher level or cut back on other types of spending. – In long run, if an increasing debt raises interest rates, it leads to lower investment that reduce capital stock and production of goods and services. 21

Objective III: Use the IS/MP model to understand how fiscal policy affects the economy in the short run 22

3. THE SHORT-RUN EFFECTS OF FISCAL POLICY 3.1 Fiscal Policy and IS Curve • Fiscal policy affects aggregate expenditure, which causes the IS curve to shift as the following figures. 23

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3.2. Using Discretionary Fiscal Policy to fight a recession • Many governments used discretionary fiscal policy to try to reduce the severity of the 2007- 2009 economic downturn. For example, President Obama signed the $814billion American Recovery and Reinvestment Act into law on February 17,2009. The act aims to increase transfer payments and spending on goods and services, to cut tax to households and firms and aid to state and local governments. 25

Now we can use IS-MP model to analyze these effect 26

3.3 Automatic Stabilizers • Automatic stabilizers is an immediate fiscal policy response to a decline in aggregate expenditure. This automatic fiscal response reduces the adverse consequences of the initial shock, so any given decrease in aggregate expenditure has a smaller effect on real GDP and employment. • As the following figure shows the automatic stabilizers at work in response to an increase in uncertainty that leads to reduced investment spending. 27

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3.4 Personal Income Tax Rates and the Multiplier (1) • How does it both relate? Why is it important? • Recall, Multiplier? How does it affect to Y? ∆𝑍 1 • Formula, 𝑁𝑣𝑚𝑢𝑗𝑞𝑚𝑗𝑓𝑠 = ∆𝐽 = 1− 1−𝑢 𝑁𝑄𝐷 ∆𝑍 1 ∆𝐽 = 1− 1−0 0.9 = 10 Ex1: Tax Rate = 0 => Analysis, if ∆𝐽 = ±1 unit ⇒ ∆𝑧 = ± 10 𝑣𝑜𝑗𝑢𝑡. ∆𝑍 1 Ex2: Tax Rate = 20% => ∆𝐽 = 1− 1−0.2 0.9 = 3.6 Analysis, if ∆𝐽 = ±1 unit ⇒ ∆𝑧 = ± 3.6 𝑣𝑜𝑗𝑢𝑡 𝑝𝑜𝑚𝑧. 29

3.4 Personal Income Tax Rates and the Multiplier (2) As results: • Multiplier effect: The process by which an initial change in autonomous expenditure leads to a larger change in equilibrium GDP. • Gov’t can determine the size of multiplier by reducing or increasing the tax rate. Tax rate and Multiplier have negative relation due to its relation ∆𝑍 1 in formula, 𝑁𝑣𝑚𝑢𝑗𝑞𝑚𝑗𝑓𝑠 = ∆𝐽 = 1− 1−𝑢 𝑁𝑄𝐷 . 30