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Econ 208

Econ 208. Marek Kapicka Lecture 17 Review. Economic Principles. Models we’ve seen Trade-offs Preferences What happens if there is an exogenous change Competitive equilibrium: prediction of the model. Government Policies. Fiscal policy What happens if government increases expenditures?

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Econ 208

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  1. Econ 208 MarekKapicka Lecture 17 Review

  2. Economic Principles • Models we’ve seen • Trade-offs • Preferences • What happens if there is an exogenous change • Competitive equilibrium: prediction of the model

  3. Government Policies • Fiscal policy • What happens if government increases expenditures? • What happens if government cuts taxes? • Regulation of Financial Institutions • Consequences of deposit insurance, suspension of convertibility

  4. Fiscal PolicyWhat happens if government increases expenditures? • Main Results: • Increase in output, labor supply • Decrease in consumption (crowding out) • Fiscal multiplier λ: $1 change in gov’t expenditures ̶> $λ change in GDP • Benchmark model: <<1; depends on efficiency of public spending, elasticity of labor supply • A model with sticky prices: can be >1

  5. Fiscal PolicyWhat happens if government increases taxes? • Main Results • Ricardian Equivalence: no change in consumption • Path of govt debt is irrelevant • Reason: no wealth effects • Failure of Ricardian Equivalence • Heterogeneity (in wealth or age) • Distortive taxes • Imperfect credit markets

  6. Fiscal PolicyFailure of RI:Heterogeneity across generations • Social Security: Intergenerational redistribution • Real effects of different social security schemes • PAYG vs. FF • PAYG better if population growth rate > interest rate

  7. Fiscal PolicyFailure of RI:Distortive taxes • Labor taxes: Laffer Curve • US vs. Europe: differences in labor taxes can explain a large part of differences in GDP per person • Ramsey problem: How should taxes be chosen? • Tax Smoothing • Use debt to finance temporary increases in spending

  8. Regulation of Financial Intermediation • Bank runs: • Productive assets need to be liquidated • deposits are liquid, while investment is illiquid • Solution: • Deposit Insurance • Possible problems: moral hazard • Suspension of Convertibility • Possible problem: time consistency

  9. Final • Monday June 12, 9-11 • Closed books closed notes • No calculator • Structure: • Multiple choice (~ 25%) • Longer questions • Examples: • Equilibrium consumption and savings • The effects of government expenditures • Distortive Taxation, Social Security • Financial Intermediation • I’ll post last year’s final today

  10. Thank You!

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