Macro Chapter 12
Terms in this set (24)
countercyclical fiscal policy
a change in government purchases or net taxes designed to reverse or prevent a recession or boom
net tax multiplier
the number a change in net taxes must be multiplied by in order to get the change in GDP
For any value of the MPC, the multiplier for a change in net taxes...
will be smaller than the government purchases multiplier by a factor equal to the MPC
if MPC = 0.6, then net tax multiplier is 60% of the value of the government purchases multiplier
If gov't purchases multiplier is 2.5, net tax multiplier is 2.5*(-0.6) = -1.5
If government purchases are raised by $100 billion, taxes are decreased by $100 billion, and transfers are increased by $100 billion, and the MPC is 0.6, what is the change in GDP (short run)?
MPC = 0.6
Expenditure multiplier = 1/(1-MPC) = 1/(1-0.6) = 2.5
Net Tax multiplier = -MPC/(1-MPC) = -0.6/(1-0.6) = -1.5
Change in net tax * net tax multiplier = change in GDP
-$200 * -1.5 = $300
Change in gov't purchases * expenditure multiplier = deltGDP
$100 * 2.5 = $250
Total change in GDP = $550
balanced budget multiplier
used when a change in government purchases is "paid for" by an equal change in taxes
Always equal to 1.0
Problems with countercyclical fiscal policy - Timing
Takes a long time to enact new policy, may be done after it is needed and cause a boom or recession
Problems w/ countercyclical fiscal policy - Irreversibility
Must be temporary to be effective, reversing fiscal stimulus is difficult because people who benefited from higher transfers/lower taxes will oppose the change
Problems w/ countercylical fiscal policy - Taxes and forward-looking behavior
If a tax change is temporary (as it must be to be effective fiscal policy), people will likely save more of it rather than spend it, the net tax multiplier will be smaller and not raise the GDP as much as hoped
Problems w/ countercyclical fiscal policy - Federal Reserve
Federal Reserve generally takes care of things faster, further action by the government may counteract/undo the actions of the Federal Reserve
Government purchases vs. government outlays
Gov't purchases is money spent on goods and services, does not include transfer payments/debt interest payments
Gov't outlays is the total disbursement of funds by the government for purchases, transfer payments, and interest on the debt
The budget deficit for any period is equal to...
Outlays - Tax Revenue
Why does the budget deficit increase during recessions?
Transfers rise (more people receive unemployment benefits) and tax revenue falls (less household income/corporate profit for the gov't to tax)
The opposite is true for expansions
Publicly held national debt as a percentage of GDP
Why is it a myth that the gov't will one day have to pay back all of the national debt?
The government does not have to pay back the amount originally borrowed as long as they make interest payments on the debt. When it does come time to pay back the owner of a government bond, the gov't will simply issue a new bond to pay for the cost of the old one.
the maximum amount that a firm (or the gov't) can borrow based on lenders' willingness to lend
Why doesn't the gov't pay back its debt?
The government benefits the public more by putting its tax revenue to better use than debt repayment
the burden of the debt
the interest payments on the national debt as a percentage of GDP
alternatively, the tax rate (taxes as a percentage of GDP) needed to pay interest on the debt
How do interest payments on foreign-owned portions of the national debt reduce US living standards?
They shift purchasing power away from US residents to foreign citizens.
How do interest payments on American owned gov't bonds effect the economy?
The government must use tax revenue to make interest payments, so a higher debt burden raises taxes. This leads to slower economic growth.
basic debt guideline
Total debt should grow no faster than GDP.
As long as the debt grows by the same percentage as the GDP, the debt ratio will remain constant. With an unchanging interest rate, the debt ratio will also remain constant
Why is it hard to reverse the effects of an increase in the debt burden after it stops increasing?
An increase in the debt burden means higher taxes to make up for the increase in interest payments. After the interest payments stabilize, the debt ratio has still increased and the higher taxes are still in place.
How can the debt burden be brought back down after a temporary violation of the guideline?
(1) Raise the growth rate of nominal GDP above the growth rate of the debt for some time - higher inflation [may not work, interest rate will eventually increase w/ inflation]
(2) lower the growth rate of the debt below the growth rate of nominal GDP for some time [gov't must run surpluses, must raise taxes or reduce outlays to do this]
sudden dramatic drop in outlays and/or large increase in taxes
opposite of fiscal stimulus
not recommended as a strategy for dealing with extreme debt because causes AE and GDP to drop (G decreases, T increases) while the budget deficit remains the same. This would actually raise the debt ratio
What would have happened if a policy had not been enacted
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