FISCAL POLICY AND AUTOMATIC STABILIZERS : WHAT MANAGERS NEED TO KNOW - - PowerPoint PPT Presentation

CHAPTER 13

FISCAL POLICY AND AUTOMATIC STABILIZERS:

TEAM 3: LEXI GRAVINO - Age aint no thang cause Im gonna do it anyway TIFFANY VEREEN - Med is my business, blood hands and balance sheets TAYLOR DURAND - TD - all I do is score no matter what NICOLE HORTH - Force from the North KARA SHANNON - Im not a playa, I just ACT a lot ANDREW GLOECKNER - Just along for the ride

WHAT MANAGERS NEED TO KNOW

FISCAL POLICY

Discretionary and non-discretionary use

• f government spending and taxation

policies to achieve macroeconomic goals

FISCAL POLICY VS. MONETARY POLICY

GOVERNMENT SPENDING

Government spending & taxation includes ALL levels of government (national, state, local, cantonal) National governments receive revenues from individual and company income taxes, tariffs, and user fees

U.S. GOVERNMENT SPENDING

Largest portion of government spending is on Health and Medicare, SS, and Defense

BUDGET DEFICITS

Deficits: governments spend more than they earn in tax revenues and fees per period Government tap the financial markets by issuing securities with varying maturities Securities issues by a national government can be purchased by virtually anyone in the world Concerns are raised when an increasing portion of a nation’s government debt is purchased by foreign residents

THE FISCAL MULTILPLIER

Fiscal Multiplier: the spending multiplier when the source of an external shock is a discretionary change in government expenditure or taxation Major Forces that Weaken Fiscal Multiplier: Automatic Changes in Tax Revenues, Government Transfers, and Imports Higher real risk-free interest rate increases the quantity of foreign funds supplied to the domestic real loanable funds market.

Outward demand shift Inward supply shift Crowding-out: occurs when government borrowing raises the real risk-free interest rate and reduces private borrowing. Therefore, a rising real risk-free interest rate crowds out individuals and businesses,rather than the government, from the real loanable funds market.

CROWDING-OUT

CROWDING-IN

Crowding-in: increase in private investments caused by greater government spending and its impact, which strengthens the fiscal multiplier Strengthens the Fiscal Multiplier Construction of a new highway Encourages business growth along road

GOVERNMENT SURPLUS

Surplus: governments spend less than they receive in tax revenues and fees Increase supply of loanable funds When taxes exceed spending, the government is often viewed as taking more away from aggregate demand than it contributes.

ACTIVE DEFICITS & SURPLUSES

Active deficits are expansionary, active surpluses are contradictory, and balanced active budgets are neutral *play an important role in stimulating or dampening economic conditions

Passive deficits are caused by the automatic stabilizers. Automatic Stabilizer: expenditures & taxes respond passively to the changing economic conditions and calm fluctuations in both real GDP and prices that would have occurred without them Government Transfers: non-discretionary changes in government expenditures **ONLY restrain economic activity NOT an independent source of economic change

PASSIVE DEFICITS & SURPLUSES

VS

FISCAL POLICY IN ACTION

Discretionary Fiscal Policies are most effective when they are used to solve demand-related problems (short term solution only)

IF INFLATION IS SPIRALING UPWARD:

• Government can reduce spending to directly trim

aggregate demand and curb the inflation

• Tax rate hikes are another way to reduce a nation's

aggregate demand

CONTROVERSIAL:

• People take it personally
• Past legislations often lock in expenditures

LAGS IN FISCAL POLICY

RECOGNITION LAG: The time it takes to recognize that a fundamental change in the economy has

• ccurred (3-6 months)

Implementation Lag: The time it takes to implement the fiscal policy (3 months-2 years) IMPACT LAG: Time it takes for policy changes to take effect (3 months-1 year)

TOTAL LAG TIME: 9 MOS - 3.5 YRS

DOWNSIDE FOR FISCAL & MONETARY POLICY LAG TIMES

The legislative policy could have changed from a cure to a policy toxins Controversial about the effectiveness of discretionary fiscal spending due to its long and variable lags

Central Bank's Balance Sheet Rises:

• Bank purchases assets (less cash)
• Central Bank's Balance Sheet Falls:

(Retiring Monetary Base)

• Bank exchanges assets for monetary

funds (more cash)

MONETARY EFFECTS OF FISCAL POLICY

WHEN ARE GOVERNMENT DEBTS & DEFICITS PROBLEMS?

Deficits & Surpluses: flow measure Debt: Stock Measure Business: Success is measured by how fast stockholders' equity increases

Borrowing = support investments Similar concept with the governemnt & investing

Large Governemnt Debt? Dont worry. The asset of any individual, company, or government MUST equal the sum of liabilities and stockholders’ equity

If US government immediately repaid trillion-dollar debt since would be the biggest redistribution of income in the history of the world Treasury securities would not be bought by investors because they are no longer risk free Re-purchase treasury bills Print more money or increase tax Money moves from tax payer to security holder Education, vaccines, national defense, law enforcement

Possibility of default: borrowing by issuing securities denominated in foreign currencies

Cant pay back debt with printed currency or capture via tax

Governments and companies technically have an unlimited lifetime Implications of debt free Government Government investments increase a nation’s net well-being ONLY if they produce goods and services with greater value than the private sector

WHEN ARE GOVERNMENT DEBTS & DEFICITS PROBLEMS?

How can a Government measure its Assets if Equity is growing? National Balance sheet Change in Equity > Change in Debt measuring economic health

Changes in a Government's Balance Sheet

International Comparison: Government Gross-Financial-Liabilities-to-GDP Ratios for Developed Nations in 2013

Debt to GDP ratios are a good measurement of debt US debt is creeping to levels normally associated with European countries as of 2013

CROWDING-OUT: WHEN IS IT COMPLETE, NONEXISTENT, OR PARTIAL?

Supply perfectly elastic (Horizontal) Change in demand No affect on real risk free interest rate Affects Equilibrium Supply perfectly inelastic (Vertical) Change in demand Affects real risk free interest rate No affect equilibrum Supply sloaping upwards elasticity in-between zero and infinity

Top Left Top Right Center

Amount of crowding out from Gov spending depends on supply & demand elasticities Real loanable fund market

1) Calculate how many people would be employed if the nation were at full employment 2) Calculate GDP per person and how much more GDP would be produced at full employment

SEPARATING ACTIVE AND PASSIVE DEFICITS & SURPLUSES

3) Calculate the automatic change in government transfer payments and taxation if the nation was at full employment 4) Calculate the active and passive deficit/surplus, and draw your conclusion

SEPARATING ACTIVE & PASSIVE DEFICITS AND SURPLUSES

A CLOSER LOOK AT THE MONETARY EFFECTS OF FISCAL POLICY

The monetary base changes

• nly when a central bank

crosses an imaginary horizontal line

• Financial intermediaries

are below the line

• The central bank is above

the line Central banks are the financial agents of their governments

Monetary Effect of Taxes

Everyone knows about paying taxes BUT where do your funds go?

• There are two options: Financial

intermediaries or Central bank

• The government generally keeps them

in the intermediaries to avoid large reductions when taxes are paid and an increase when government expenditures are made

Monetary Effects of Government Taxes

• Taxpayers transfer $10 Billion to

government

• Hold the funds at financial

intermediaries in Tax & Loan accounts(T&L)

• T&L rises by $10 billion
• Taxpayers decrease by $10 billion
• There is a change in the ownership
• f deposit liabilities

Tax payments have no effect on a nation’s monetary base because all the transactions are below the line (in the intermediaries)

Monetary Effects of Government Transfers

• Government Deposits at the Central Bank since they still need to write checks on & make wire transfer
• They perform finance services; such as tax collection, issuance of new debt, and administration of

payments on outstandingdebts. **(Right now assuming government treasuries hold all their deposits in financial intermediaries)

• Government transfer $10 billion to central bank

from intermediaries

• The monetary base decreases by $10 billion
• The financial intermediaries lose $10 billion of

deposit liabilities

• Will also lose an equal amount of reserves in

the form of deposits at the central bank

• The transfer of funds is independent of the

public’s payment of taxes

Monetary Effects of Government Spending

• Government spent $15 billion on a

new highway

• The T&L account will fall by $15

billion

• Highway contractor’s account rises
• The reserves financial intermediaries

and the monetary base would remain unchanged Government spending has no effect on the nation’s monetary base because all transactions are below the line

Monetary Effects of Government Borrowing

Government borrowing has no effect on the nation’s monetary base because all transactions are below the line

• Government borrowed $20 billion
• The checking accounts of

savers/lenders transfer to the T&L accounts

• The banking system reserves and the

monetary base would remain unchanged

PLEASE TAKE OUT YOUR PHONES

https://www.brookings.edu/blog/up-front/2019/01/04/the-hutchins-center-explains-how-worried-should-you-be-about-the-federal-debt/ (slide 16) https://www.cia.gov/library/publications/the-world-factbook/rankorder/2186rank.html (slide 17) https://www.investopedia.com/articles/economics/12/fiscal-or-monetary-policy.asp https://www.economicshelp.org/blog/1850/economics/difference-between-monetary-and-fiscal-policy/ (Slide 2)

Works Cited