Flashcards in Week 11 - fiscal policy Deck (16):
What is an automatic stabiliser?
gov spending or taxes that automatically increase or decrease with the business cycle. E.g. welfare payments are countercyclical and increase with falling output, raising G and increasing AD.
Gov takes action to change G or T to achieve its economic objective
What is the gov purchase/tax multiplier
GPM = change in equilirium GDP/change in gov purchases or taxes
What are policy time lags?
- implementation lag
- impact lag
- recognition lag
What are political asymmetries?
Expansionary policy is typically more attractive politically and can be hard to unwind. Elected officials may opt for the best option politically rather than economically.
What is resource crowding out?
situation where with full employment, an increase in G simply replaces private expenditure
What is financial crowding out?
occurs when gov borrowing leads to higher interest rates, which discourages private investment.
Formula for gov budget constraint
Gov spending + transfers + interest repayments = taxes + new debt + change in money supply
Why is a budget not always balanced?
maintaining a balanced budget each year may involve policies that may destabilise the economy - long-run fiscal solvency needs to be considered though.
Debt to fund long-run infrastructure makes sense, the problem arises when repayments are too burdensome (implies opportunity cost)
What happened in the GFC?
- world equity markets contracted
- world trade fell
- interest rates were cut significantly
- government went into deficit to stimulate the economy (opposite of Great Depression). This follows Keynesian thinking: in severe contractions, demand doesn't respond normally so gov intervention is necessary
What happened in the GFC in Australia?
- Australia acted quickly in getting money to people and institutions that would spend it
- nation building and jobs plan
- spending and taxing directed to highest MPC groups
such as tax bonus payments and spending to schools
- spending happened quickly to prevent permanent sluggishness
What is the intertemporal budget constraint?
measure of gov fiscal constraint over time
present value of spending + present value of debt and present value taxes.
What is ricardian equivalence
Argues fiscal policy won't work as any increase in G has to be financed by higher taxes in the future. Rational agents will figure this out and cut back consumption in response to higher gov spending or cut in taxes. In only makes sense in the long run and real world evidence is limited
What is the problem with a single currency?
You can't expand aggregate demand by raising net exports. This happened in the Eurozone.
What is the level of debt limited to
Amount the gov can credibly be expected to pay, partly depends on GDP level. Can grow if GDP grows faster