Flashcards in 37. Fiscal Policy Deck (22):
Define fiscal policy.
Federal government policy on taxes, spending, and borrowing designed to influence business fluctuations.
What are two general fiscal policy categories used for fighting recession?
1) Government spends more money (higher taxes).
2) Reduced taxes; people have more spending money.
What is the best case for fiscal policy in an aggregate demand curve?
They can affect government spending to compensate for the reduced consumer spending.
This shifts the curve right and up.
Where does money from increased government spending come from?
Increased taxes and borrowing.
Some quarters will have reduced aggregate demand but in the best case it should create more growth.
As G (with arrow) increased, C increases.
What is the multiplier effect?
Additional increase in AD when expansionary fiscal policy increases income and thus consumer spending.
E.g. Government spending on a bridge pays workers who then have more money to spend on other businesses and so on.
What are the four limits to fiscal policy?
1) Crowding out --> crowds out private spending, AD is reduced or neutralised.
2) A drop in the bucket --> Economy is so large that increased governmental spending has small impact.
3) Timing --> difficult to time fiscal policy so that AD curve shifts at the right moment
4) Real shocks --> Shifting AD doesn't combat real shocks. (It's not AD but that people don't have enough to spend).
Define crowding out and the two scenarios for it.
Decrease in private spending when government is spending.
Scenario 1: higher taxes means individuals spend less.
Scenario 2: People buy more government bonds than private ones so investment declines. Higher bonds means higher interest rates --> people save more than spend.
When is it best to use fiscal policy?
When people fear spending.
When is bond-financed expansionary fiscal policy most effective?
When private sectors are reluctant to spend or invest (they won't invest to private industries anyways).
What are the tax tools of fiscal policy? When is it ineffective?
Tax rebates and tax cuts --> excess money from those increased individual AD.
Ineffective if excess money is used to pay off debts (neutralises the effort).
What is the difference between tax rebates and tax cuts?
Tax rebates have a check, it doesn't create incentive to invest or work. (Spending effect)
Cutting marginal tax rates has two effects: 1) Increased spending 2) Incentive to invest/work
What is the Ricardian equivalence?
People see lower taxes as higher taxes in the future. They save the tax cuts.
What does a "drop in the bucket" government spending require?
Large government spending in the short run to increase AD (hard to achieve); most times the economy is too big so this has little impact.
What are the five lags for timing regarding fiscal policy?
1) Recognition lag (problem must be recognised)
2) Legislative lag (congress must propose/pass a plan)
3) Implementation lag (bureaucracies must implement)
4) Effectiveness lag (plan takes time to work)
5) Evaluation and adjustment lag
Does monetary (banks) or fiscal (government) policy respond faster? And when does fiscal policy have an advantage over monetary policy?
Monetary policy responds faster (e.g. the day right after 9/11).
Fiscal policy's advantage is effectiveness; has direct impact on the economy whereas monetary policy relies on willingness of banks.
Define automatic stabilisers.
Changes in fiscal policy that stimulate AD in a recession without explicit action by policymakers.
Built right into tax and transfer systems; take effect without significant lags.
What are examples of automatic stabilisers?
Slight cuts in taxes and slightly higher interests to soften the blow.
Welfare and transfer systems focus on those in desperate need.
Consumption smoothing by people.
Private innovations like credit (borrowing money instead of harsh cuts when you retire).
Why is fiscal policy ineffective against real shocks?
An increase in G only increases growth a little bit and increased inflation by a lot.
True or false: governments find it easier to increase spending during bad times than to increase taxes during good times, thus having a deficit for most years and having a debt that increases.
What does that lead to?
A large part of the government's budget is spend on interest payments therefore there is little room for expansionary fiscal policy.
When can expansionary fiscal policy reduce real growth? What is an example of a country that faced this?
When the government's debt is too large.
Argentinian crisis where their debt was so large that fiscal policy caused their GDP to drop even more.
When is fiscal policy a good idea?
- immediate emergency when a short-run economic boost is needed (war, worsening depression, natural disaster)
- a shock relating to AD
- high unemployment --> no crowding out