Ch 29 - Fiscal Policy

Friday, March 09, 2012

2:35 AM

Fiscal Policy

Government spending/taxing/transferring to achieve macroeconomic objectives

Federal budget

Amount of government spending and tax revenues



Income tax
corporate income tax
investment income

Outlays (spending)

Transfer payments
debt interest


Budget Balance

Budget surplus

More revenue

Budget deficit

More outlays

Balanced budget

They're equal!


Government debt



Supply side effects

Reduce income
decrease incentive to work

Macroeconomic effects

Affects the business cycle.
Can affect GDP


Real interest rate

Real after-tax rate


Laffer curve


Discretionary fiscal policy

Initiated by an act of Parliament

  • Stimulus Plans
  • New tax policies

Automatic fiscal policy

Triggered by the state of the economy

  • Transfer payments (EI)


Government expenditure multiplier

Magnification effect of a change in government expenditure on goods on AD

increase in government expenditure
increase income
increase consumption expenditure
increase AD

Autonomous tax multiplier

Magnification effect a change in autonomous taxes on AD

Smaller than the government expenditure multiplier.

Balanced budget multiplier

Effect on AD of a simultaneous change in government expenditure and taxes (that leaves budget balance unchanged)


Stabilizing business cycle (discretionary)

Recessionary gap

Increase in government spending
tax cut

result in increase in AD

Inflationary gap

Decrease in government spending
tax increase

result in a decrease in AD


Limitations of discretionary fiscal policy

Recognition lag

Time to realized that a policy is needed

Law-making lag

Passing law takes time

Impact lag

Effect takes time


Automatic stabilizers

Without explicit action by government

Induced taxes

Tax that vary with GDP

Means-tested spending

Spending according to economic need


Structural surplus or deficit

Budget balance that would occur if economy were at full employment (real GDP = potential)

Cyclical surplus or deficit


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