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Fiscal Policy

Fiscal Policy. Frederick University 20 14. Fiscal policy. A system of goals, tools and instruments to affect GDP and employment Subject – the Treasury (the Ministry of Finance) Goals : Long run or short run expansion or restriction Discretion or rule-based policy

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Fiscal Policy

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  1. Fiscal Policy Frederick University 2014

  2. Fiscal policy A system of goals, tools and instruments to affect GDP and employment • Subject – the Treasury (the Ministry of Finance) • Goals: • Long run or short run • expansion or restriction • Discretion or rule-based policy • Fine tuning of the economy • Stabilization policy • structural policy • Tools and instruments: • Government revenues • Government spending – government purchases and transfer payments

  3. Government Budget Assessment of government revenues and expenditures, deficits and surpluses of government finance expenditures revenues Taxes G Transfer payments

  4. Elementary Model of Fiscal Policy ThroughG • Expansion – increase in G and in AD • Restriction – decrease in G and reductioninAD Through Taxes • expansion - reduction in T and increase in AD • Restriction – increase in T and reduction inAD The taxation multipliershowsthe change in GDP caused by a change in the tax rate taxation multiplier = - MPC/MPS

  5. GDP gaps Price level Price level AD AS AD AS GDP GDP Y* Y2 Y1 Y* Y2 – Y* = inflationary gap Y* - Y1 = recessionary gap

  6. Fiscal policy on the AE diagram AE2 AE AE1 45o Y2 Y Y1 Expansionary fiscal policy – G increases and AE rise, as a result, Y rises

  7. Budget deficit (surplus) and government debt • Budget deficit (surplus): • Primary deficit (surplus) = current revenues-current expenditures • Secondary deficit (surplus) = primary deficit (surplus) + interest payments on domestic debt • Cash deficit (surplus) = secondary deficit (surplus) + flows of external revenues and payments • Cyclical vs. structural deficit (surplus) • Government debt

  8. Effectiveness of the Fiscal Policy • Discretionary vs. Rule-based policy • Built-in stabilizers: • in the budget – income taxes, corporate taxes, social payments • in the economy – excess capacity, purchases of foreign goods, corporate dividend policy, autonomous spending • Crowding-out and crowding-in effect • Time lags

  9. Supply-side Fiscal Policy A system of goals, tools and instruments to affect aggregate supply Goals: • Increase in productivity • Reduction of the inflationary pressure • Reduction in the need for government spending • Reduction of government debt • Reduction of the crowding-out effect Effectiveness - Depends on the elasticity of factor supply factor payments and disposable income

  10. Laffer Curve Т t 0 100%

  11. Discussions on the effectiveness of fiscal policy Different time horizons and different assessment of the: • Stability of the macroeconomic equilibrium • Elasticity of investment demand as regard the interest rate • Expectations – adaptive vs. rational • Dynamics of the aggregate supply

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