Fiscal Policy2012

Copyright 2004 McGraw-Hill Australia Pty Ltd

PPTs t/a Macroeconomics 7/e by Jackson and McIver

Slides prepared by Muni Perumal, University of Canberra, Australia

9-1

Learning Objectives

• Discuss the implications of and complications associated with fiscal policy within the aggregate demand–aggregate supply framework

Copyright 2004 McGraw-Hill Australia Pty Ltd

PPTs t/a Macroeconomics 7/e by Jackson and McIver

Slides prepared by Muni Perumal, University of Canberra, Australia

9-2

Federal Government Finance• Federal expenditures

– large expenditure on social security and welfare– specific purpose grants

• Federal revenues– Personal income tax– Company income tax– Indirect and other taxes

• GST• excise tax

Copyright 2004 McGraw-Hill Australia Pty Ltd

PPTs t/a Macroeconomics 7/e by Jackson and McIver

Slides prepared by Muni Perumal, University of Canberra, Australia

9-3

Discretionary Fiscal Policy

• The deliberate manipulation of taxes and spending by government for the purpose of altering real GDP and employment, controlling inflation and stimulating economic growth

• Not all fiscal policy is deliberate, a range of automatic stabilisers are discussed later

Copyright 2004 McGraw-Hill Australia Pty Ltd

PPTs t/a Macroeconomics 7/e by Jackson and McIver

Slides prepared by Muni Perumal, University of Canberra, Australia

9-4

Expansionary Fiscal Policy

• Increased government spending or lower taxes or increased transfer payments (social security payments) to reduce the effects of recession, i.e. boost GDP and reduce unemployment

Copyright 2004 McGraw-Hill Australia Pty Ltd

PPTs t/a Macroeconomics 7/e by Jackson and McIver

Slides prepared by Muni Perumal, University of Canberra, Australia

9-5

Expansionary Fiscal Policy

Copyright 2004 McGraw-Hill Australia Pty Ltd

PPTs t/a Macroeconomics 7/e by Jackson and McIver

Slides prepared by Muni Perumal, University of Canberra, Australia

9-6

ASLS

Qp

Pric

e le

vel

Real gross domestic product

AS1

AD2

Q1

AD1

P1

Q2

P2

Contractionary Fiscal Policy

• Decreased government spending or higher taxes or a reduction in transfer payments in order to reduce inflation during a boom

Copyright 2004 McGraw-Hill Australia Pty Ltd

PPTs t/a Macroeconomics 7/e by Jackson and McIver

Slides prepared by Muni Perumal, University of Canberra, Australia

9-7

Contractionary Fiscal Policy

Copyright 2004 McGraw-Hill Australia Pty Ltd

PPTs t/a Macroeconomics 7/e by Jackson and McIver

Slides prepared by Muni Perumal, University of Canberra, Australia

9-8

ASLS

Qp

Pric

e le

vel

Real gross domestic product

AS1

AD1

Q1

AD2

P1

P2

Non-Discretionary Fiscal Policy• Built-in or automatic stabilisers that operate without

requiring explicit action by policy-makers, they are the result of a progressive income taxes and a social security system

• During recessions: Tend to increase government deficits (or reduce surplus) through lower taxes and higher welfare payments

• During inflationary periods: Tend to increase government surpluses (or reduce deficits) through higher taxes and lower welfare payments

Copyright 2004 McGraw-Hill Australia Pty Ltd

PPTs t/a Macroeconomics 7/e by Jackson and McIver

Slides prepared by Muni Perumal, University of Canberra, Australia

9-9

Automatic or Built-in Stabilisers

• Tax receipts: Increase as real GDP increases, so the economy slows

• Transfers: Decrease as real GDP increases, but increase when the economy slows so GDP and AD increase.

• Do not fully correct the economy, only reduces the severity of fluctuations

• Useful when economy is operating around full employment

• Can cause problems: Fiscal DragCopyright 2004 McGraw-Hill Australia

Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson

and McIverSlides prepared by Muni Perumal, University of Canberra, Australia

9-10

Automatic or Built-in Stabilisers

Copyright 2004 McGraw-Hill Australia Pty Ltd

PPTs t/a Macroeconomics 7/e by Jackson and McIver

Slides prepared by Muni Perumal, University of Canberra, Australia

5-11

Le

vel o

f b

usi

ne

ss a

cti

vit

y

Time

Flatten out the fluctuations in the business cycle, but do not eliminate them completely

Problems with Fiscal Policy in Practice

• Problems of timing– Recognition lags– Administrative lags– Operational lags

• Political problems– Other economic goals, economic growth

complements and conflicts with other policies– Expansionary bias, often not used stimulate rather

than slow the economy– The political cycle may accentuate the business cycle.

Copyright 2004 McGraw-Hill Australia Pty Ltd

PPTs t/a Macroeconomics 7/e by Jackson and McIver

Slides prepared by Muni Perumal, University of Canberra, Australia

9-12

Fiscal Policy and Aggregate Supply

• Fiscal policy, especially tax changes, affects not only aggregate demand but can affect aggregate supply

• Tax changes in the form of incentives to businesses and individuals as well as government spending in infrastructure can lead to a rightward shift in the AS in addition to increasing AD, providing a further stimulus to the economy in terms of lower prices and higher GDP

Copyright 2004 McGraw-Hill Australia Pty Ltd

PPTs t/a Macroeconomics 7/e by Jackson and McIver

Slides prepared by Muni Perumal, University of Canberra, Australia

9-13

Supply-Side Effect of Fiscal Policy

Copyright 2004 McGraw-Hill Australia Pty Ltd

PPTs t/a Macroeconomics 7/e by Jackson and McIver

Slides prepared by Muni Perumal, University of Canberra, Australia

9-14

ASLS

Qp

Pric

e le

vel

Real gross domestic product

AS1

AD2

Q1

AD1

P1

AS2

Q2

P2

P3 =

Q3

9-25

9-26

9-27

9-28