Scribd
Upload
21 views29 pages

Ch. 11 Fiscal Policy

Uploaded by

elmorris91
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
21 views29 pages

Ch. 11 Fiscal Policy

Uploaded by

elmorris91
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
You are on page 1/ 29

Chapter 11

Fiscal Policy

Prepared by Murray Davidson, Centennial College.


© 2020 by McGraw-Hill Education Ltd. 1
Learning Objectives
After this chapter you will be able to:

Identify expansionary and contractionary fiscal


policies, which are used by governments seeking
economic stability

Outline the multiplier effect of fiscal policy

Distinguish between budget surpluses and


deficits and their impact on public debt.

© 2020 by McGraw-Hill Education Ltd. 2


Stabilization Policies
Stabilization policy is government policy designed to
lessen the effects of the business cycle.

 It can be either expansionary or contractionary.


 Expansionary policy attempts to reduce

unemployment and stimulate output.


 Contractionary policy attempts to stabilize prices

and reduce too high growth of output.

© 2020 by McGraw-Hill Education Ltd. 3


Stabilizing the Business Cycle
FIGURE 11.1

© 2020 by McGraw-Hill Education Ltd. 4


Stabilization Policies (b)
Stabilization policy can take the form of either fiscal policy or
monetary policy.

 Fiscal policy uses taxes and government purchases.


 Expansionary fiscal policy involves more government

purchases and/or lower taxes to shift AD rightward.


 Contractionary fiscal policy involves fewer government

purchases and/or increased taxes to shift AD leftward.

 Monetary policy uses interest rates and the money


supply.

© 2020 by McGraw-Hill Education Ltd. 5


Expansionary Fiscal Policy
FIGURE 11.2

© 2020 by McGraw-Hill Education Ltd. 6


Contractionary Fiscal Policy
FIGURE 11.3

© 2020 by McGraw-Hill Education Ltd. 7


Automatic Stabilizers

 Automatic stabilizers are built-in measures such as


taxes and transfer payments to lessen the effects of
the business cycle.
 A contracting economy decreases net tax
revenues which increases spending and incomes.
 An expanding economy increases net tax
revenues which decreases spending and incomes.

© 2020 by McGraw-Hill Education Ltd. 8


The Multiplier Effect (a)
The multiplier effect is the magnified impact of a
spending change on AD.

 An initial spending change produces income and


part of this new income becomes new spending.

 This process is repeated with each spending


round smaller than the last.

© 2020 by McGraw-Hill Education Ltd. 9


The Multiplier Effect (b)
 Each new spending round is determined by the
marginal propensity to consume (MPC), which
measures the effect of an income change on
domestic consumption.

 Each new spending round is also determined by


the marginal propensity to save or withdraw
(MPW), which measures the effect of an income
change on savings/withdrawals (with MPC and
MPW always summing to one).

© 2020 by McGraw-Hill Education Ltd. 10


Impact of Higher Government
Purchases FIGURE 11.4

© 2020 by McGraw-Hill Education Ltd. 11


The Spending Multiplier
 The spending multiplier:

 is the value by which an initial spending change is


multiplied to give the total shift in the AD curve
 equals (1/MPW)

 The actual change in equilibrium output is less than


the change in AD found using the spending
multiplier because of price changes

© 2020 by McGraw-Hill Education Ltd. 12


The Multiplier Effect and Price
Changes FIGURE 11.5

© 2020 by McGraw-Hill Education Ltd. 13


Changes in Government
Purchases/Taxes
 A change in government purchases causes an initial
spending change of the same amount (and in the
same direction).

 A tax change has a smaller initial impact on


spending (and in the opposite direction).
 The initial spending change is found by

multiplying the tax change by the marginal


propensity to consume (and then reversing the
sign of this change).

© 2020 by McGraw-Hill Education Ltd. 14


Benefits and Drawbacks of Fiscal
Policy
 Fiscal policy has two main benefits:
 It can be focused on particular regions.

 It has a relatively direct impact on spending.

 Fiscal policy has three main drawbacks:


 It is subject to delays (recognition lag, decision

lag, impact lag).


 It is politically visible.

 It is closely related to public debt, the amount

owed by the federal government.


© 2020 by McGraw-Hill Education Ltd. 15
The Impact of Fiscal Policy (a)
A government is running a:

 balanced budget when its expenditures and


revenues are equal

 budget surplus when its revenues exceed its


expenditures

 budget deficit when its expenditures exceed its


revenues

© 2020 by McGraw-Hill Education Ltd. 16


The Impact of Fiscal Policy (b)
 Government debt is the sum of all previous budget
deficits.
 When a government has a:

 budget deficit, its total debt increases by the same

amount
 budget surplus, its debt decreases by the same

amount.
 In the past, the federal government tended to run

budget deficits.
 As a consequence, government total debt and debt

payments were on the rise.


© 2020 by McGraw-Hill Education Ltd. 17
Fiscal Policy Guidelines
There are three principles that can guide government
fiscal policy:

 annually balanced budgets

 cyclically balanced budgets

 functional finance

© 2020 by McGraw-Hill Education Ltd. 18


Recent Fiscal Policy in Canada
 There has been a move from functional finance
toward cyclically balanced budgets.
 Total government deficits were highest during the

early 1980s and 1990s.


 The 1980s deficits were largely discretionary

while the 1990s deficits were related to


automatic stabilizers.
 The budget surpluses in the late 1990s and early

2000s were due to automatic stabilizers, lower


interest rates, and government spending cuts.

© 2020 by McGraw-Hill Education Ltd. 19


The Debate Over Public Debt (a)
Supporters of using public debt say:

 public debt provides benefits by reducing the


costs of unemployment
 about 80 percent of federal debt is held by

Canadians, or owed to ourselves


 when debt is used to create productive assets, it

is not necessarily a problem


 there have been times in the past when public

debt as a percent of GDP was higher than now

© 2020 by McGraw-Hill Education Ltd. 20


Public Debt and GDP (billions of
current dollars) FIGURE 11.6

© 2020 by McGraw-Hill Education Ltd. 21


The Debate Over Public Debt (b)
Those against using public debt say:

 public debt charges rise


 provincial and territorial debts need to be taken

into account as well


 there are limits to how much taxes can be raised

to pay public debt charges


 there are potential future burdens associated

with the the amount of Canada’s government


debt held by foreigners

© 2020 by McGraw-Hill Education Ltd. 22


Government Debt Relative to GDP
FIGURE 11.7

© 2020 by McGraw-Hill Education Ltd. 23


Economist Extraordinaire (a)
John Maynard Keynes:

 created a theory to support governments actively


combating the Great Depression
 emphasized the role of aggregate demand in

determining output in the economy


 opposed the neoclassical view that a decline in

wages leads to eliminating unemployment.

© 2020 by McGraw-Hill Education Ltd. 24


A Flexible Labour Market
FIGURE A

© 2020 by McGraw-Hill Education Ltd. 25


An Inflexible Labour Market
FIGURE B

© 2020 by McGraw-Hill Education Ltd. 26


Economist Extraordinaire (b)
 Keynes opposed Say’s Law (which states that supply
creates its own demand).

 He argued that income levels rather than interest


rates adjust to bring a balance between total
injections and total withdrawals.

© 2020 by McGraw-Hill Education Ltd. 27


Public Debt and GDP

© 2020 by McGraw-Hill Education Ltd. 28


Conclusion
Identified expansionary and contractionary fiscal
policies and how they are used by the government
to stabilize economy.

 Explained the multiplier effect of fiscal policy based


on MPC and MPW.

Differentiated between budget surpluses and


deficits and examined their impact on public debt.

© 2020 by McGraw-Hill Education Ltd. 29

You might also like