Economics 5310
The topic for this session will be concerned with Fiscal
Policy, its impact, and controversies.
In this country we have emphasized macroeconomic policy as the responsibility of the Fed. However, in many foreign countries fiscal policy is used as an important stabilizing tool. As we have seen for our aggregate expenditures model, fiscal policy can have an immediate and significant effect on aggregate demand. Government infrastructure investment and tax policy, as well as the adverse effect of “crowding out” can also affect aggregate supply. The current fiscal surplus and the impact of its future allocation among more spending, lower taxes, and debt repayment is also a current area of controversy. A discussion of fiscal policy’s impact on the aggregate expenditure model is found in Chapter 12 in our textbook. Extensions of the impact of net income taxes on the aggregate expenditure multiplier is shown in Appendix 13 in our textbook. The impact of tax policy on investment decisions is discussed on pages 304-5 in Chapter 14 in our textbook.
The evolution of fiscal policy versus monetary policy as stabilizing tools in our economy is described in chapter 17 of our textbook We will discuss how macroeconomic though has evolved in this century from the early classical school, to the early Keynesian school, the Monetarist school, the new classical school, and the new Keynesian school. The evolving majority consensus among economist is described as the new Keynesian school that agrees with the view that fiscal policy can deal with recessionary gaps in the short-run, but it encompasses ideas from both the monetarist and the new classical schools of thought.
I. Government Spending and Revenues
1. Government spending, transfer payments, and net interest as a percent of GDP
2. Government taxes and other revenues
3. The national debt as a percentage of GDP
4. Measuring the impact of fiscal policy as change in surplus or deficit at potential output levels
II. Fiscal Policy for Stabilization
1. Automatic stabilizers (taxes and transfers that depend upon income)
2. Changes in government purchases
3. Changes in autonomous taxes and the income tax rate
III. Issues in Fiscal Policy
1. Lags (compared with monetary policy)
2. Crowding out
3. Effect on transitory versus permanent income
4. Supply-side economics
IV. The Impact of the National Debt
1. Failure to account for net worth and government consumption versus investment
2. Measured relative to GDP
3. National debt and national bankruptcy—a fallacy
4. Repercussions of debt management
5. Can the burden of the debt be shifted to future generations?
V. Effect of Fiscal Policy on Aggregate Expenditures Function (Appendix 13)
1. Changes in government spending shifts aggregate demand
2. Changes in autonomous taxes shifts aggregate demand by less in opposite direction
3. Changes in income tax rate rotates aggregate demand and changes the multiplier
VI. What to do with the federal budget surplus?
1. Impacts of more spending, lower taxes, and debt repayment
2. The political economy of tax cuts:
http://www.dismal.com/thoughts/th_bn_121499.stm
3. A question of priorities and economic impact on consumption versus investment spending
http://www.dismal.com/thoughts/wspd.stm
I. The Early Classical School, Great Depression, and Keynesian Economics
1. Twin pillars of Classical School: Say’s Law of Markets and Quantity Theory of Money
2. The impact of the Great Depression on classical school predictions
3. Keynes versus the twin pillars of the classical school
II. Keynesian Economics in the 1960s and 1970s
1. Expansionary policy during the Kennedy-Johnson years
2. Challenges to Keynesian economics from the supply side in 1970
3. The Monetarist challenge to Keynesian economists
4. New Classical School and the role of the supply side and rational expectations
5. Lessons learned from the 1970s
III. The Emergence of Consensus in the 1980s
1. The revolution of monetary policy
2. The stepping back of fiscal policy
3. The rise of new Keynesian economics
IV. Ingredients of New Keynesian Economics
1. Incorporates important monetarists and new classical ideas into Keynesian economics
2. Recognized inadequacy of single approach (money, aggregate supply, etc.) to explain macroeconomic change
3. Questions stability of the velocity of money and rational expectations response to policy
4. Recognizes the impact of imperfections in microeconomic markets (lack of information, role of risk as a determinant of behavior, menu costs of price changes, efficiency wages, hysteresis from insider-outsider employment)
5. Try to apply theory to reach conclusions concerning the following published quotes: News quotes