Transcript Chapter I Economics and the Economy

Chapter 7
Government, Fiscal Policy &
Real GDP
MACROECONOMICS BY CURTIS,
IRVINE, AND BEGG
SECOND CANADIAN EDITION
MCGRAW-HILL RYERSON, © 2010
Learning Outcomes
2
This chapter explains:
 The government sector of Canadian economy
 The government sector in the circular flow
 How taxes & government expenditure affect Ye
 The government’s budget function & budget balance
 Fiscal policy, the government’s budget function & balance
 Automatic stabilizers and discretionary fiscal policy
 The public debt and the government’s budget balance
 Government, aggregate demand, and equilibrium output
Chapter 7
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Government Outlays in Canada 2007
3
 Government in Canada = federal, provincial,
municipal & hospital.
Chapter 7.1
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The General Govt Sector in G7 Countries 2006
4
• Canada’s budget surplus and debt ratio were unique in G7 in
2006.
• Recession & fiscal stimulus 2008 -10  budget deficits in 2008 -Chapter 7.1
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Government and the Circular Flow
5
• G is an autonomous component of AE
• Taxes minus transfers = Net taxes NT, NT = tY
• t ≡ net tax rate = ∆NT/∆Y
• Taxes  YD ≡ Y – NT  ∆C component of AE
• The Govt budget balance BB = NT - G,
BB = tY – G
•  Federal Government Budget 2007
Chapter 7.2
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The Federal Govt Budget: Canada 2007
6
Chapter 7.2
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Govt Expenditure, Net Taxes & Ye
7
• Govt expenditure G = G0 is an autonomous part of AE
• Then A0 = C0 + I0 + G0 + X0 – Z0
 Net tax, NT = tY,
 ∆NT induced by ∆Y ∆slope AE  ∆multiplier ∆Y/∆A
Chapter 7.3
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Net Taxes & Consumption
8
 Net Taxes(NT = tY) reduce YD at every Y
YD = Y – NT = Y - tY
 Then C = C0 + cYD
 C = C0 + c(Y – tY)
 C = C0 + c(1 – t)Y
 C is lower at every Y when t > 0
 ∆t  ∆C at every Y,
Chapter 7.3
∆C/∆t < 0
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Net Taxes & Consumption
9
A Numerical example: ∆C/∆t < 0
Assume: NT = tY = 0.15Y,
YD = Y – NT = Y – 0.15Y
Then: C = 20 + 0.8YD
C = 20 + 0.8(Y – 0.15)Y
C = 20 + 0.68Y
Now ∆C/∆Y = 0.68:
Chapter 7.3
Slope of C function = 0.68
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Net Taxes & Consumption
10
C
Taxes ∆C at every Y by – ctY
C = 20 + 0.8Y, t = 0
C = 20 + 0.68Y, t = 0.15
260
224
∆C = 0.8(tY) = 0.8(0.15 x 300) = 36
20
ΔC/ΔY = MPC(1-t) = 0.8 x 0.85 = 0.68
300
Chapter 7.3
Y
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The Effect of Taxes and Government Spending on
Equilibrium Income
11
Chapter 7.3
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Government Expenditure, Taxes,
and Equilibrium Output
12
• NT = 0, ∆G is ∆A  ∆Y = ∆A x multiplier
Y = AE
AE’ = 105 + 0.6Y
AE = 80 + 0.6Y
AE
105
∆G = 25
∆A = 25
∆Y = (1/(1-0.6) = 62.5
∆G=25
80
450
∆Y = 62.5
200
Chapter 7.3
262.5
Y
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Government Expenditure, Taxes,
and Equilibrium Output
13
Adding NT = tY to finance G
Y = AE
AE’ = 105 + 0.6Y
AE
∆t =0.125
105
∆Y
o
Chapter 7.3
AE’’ = 105 + 0.5Y
∆t ∆YD ∆C
(∆AE/∆Y)
≡ ∆ slope of AE
 ∆Multiplier
 ∆Ye
450
210
262.5
Y
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The Multiplier Revisited
14
1
The multiplier 
1 - slope of AE
Y
1

A 1 - c(1- t)  z
• z & t reduce the slope of AE
• Lower AE slopes  smaller Multipliers
Chapter 7.3
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The Govt Budget and Budget Balance
15
 Government revenue & spending:
 Net tax revenue: NT = tY
 Expenditure on goods & services: G
• Govt budget balance: BB = revenue - expenditure
BB = tY – G
Chapter 7.4
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Determinants of Govt Budget Balance BB
16
The BB depends on:
1. Net tax rate (t) set by govt
2.
Expenditure (G) set by the govt
3.
GDP (Y) determined by AE and AD
Chapter 7.4
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The Govt’s Budget & Budget Balance
17
• G0 & t0 set by govt Budget Plan
• Then BB determined by Y, ∆Y  ∆BB
G, NT
NT = t0Y = 0.2Y
Deficit
Surplus
Balanced
200
G0 = 200
600
Chapter 7.4
1500
Y
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The Govt’s Budget Function
18
The Govt’s Fiscal Plan sets t0 & G0:
NT = t0Y,
G = G0
Budget Function: BB0 = t0Y - G0
E.g. if BB0 = 0.2Y – 200
Chapter 7.4
∆BB/∆Y > 0
Y
NT
G
BB
200
40
200
-160
600
1000
120
200
200
200
- 80
0
1600
320
200
120
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The Govt’s Budget Function
19
A Govt Budget Function: BB0 = 0.2Y - 200
+BB
BB0 = 0.2Y-200
+80
0
-80
600
1000
1400
Y
-200
• This fiscal program sets t = 0.2 & G = 200
• The BB depends on Y:
∆BB/∆Y > 0
Chapter 7.4
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Fiscal Policy & Govt Budget Balance
20
Fiscal policy objectives:
 Stabilize equilibrium Y at YP &/or,
 Manage budget deficits & public debt
Fiscal policy instruments:
 Set net tax rate (t), both taxes & transfers
 Set government expenditure (G)
∆ Fiscal Policy ≡ ∆Fiscal Plan  ∆BB function
Chapter 7.5
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Expansionary Fiscal Policy
21
∆G > 0 ↓ Recessionary Gap
Y = AE
AE1
YP
AE
AE0
A0 + ∆G
(Y0 – YP) = Recessionary Gap
ΔG > 0
∆Y = ∆G x multiplier
A0
∆Y
450
o
Chapter 7.5
Y0
YP
Y
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Restrictive Fiscal Policy
22
∆t > 0 to ↓ Inflationary Gap
AE2
YP
AE
Δt > 0
AE3
∆t > 0  ↓multiplier
 ↓ Ye  YP
∆Y < 0
A0
(Y2 – YP) > 0 Inflationary gap
450
o
Chapter 7.5
Yp
Y2
Y
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The Structural Budget Balance
23
Indicators of Fiscal Policy Stance
 Actual BB: an ambiguous fiscal indicator
 ∆Y &/or ∆Fiscal program  ∆ BB
 Structural budget balance (SBB) ≡ BB estimated @ YP
 SBB = t0YP – G0
 ∆Fiscal program (∆t0 &/or ∆G0)  ∆SBB
 ∆SBB  shift BB function ≡ ∆Fiscal Policy Stance
Chapter 7.5
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Actual & Structural Budget Balances
24
BB0 = t0Y – G0
SBB0 = t0YP – G0
BB0 = t0Y – G0
+ BB
C
+BB2
BB > 0
SBB0
A
0
Y1
-BB1
BB < 0
B
-G0
Yp
Y2
Y
∆BB/∆Y > 0
∆SBB/∆Y = 0
– BB
Chapter 7.5
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Automatic & Discretionary Fiscal Policy
25
 Automatic fiscal stabilizers

Reduce slope of AE  reduce ∆Y/∆A (the multiplier)

NT = tY  (∆AE/∆Y) = [(1 – t)(c – z)]

Built into budget program by setting t in NT = tY

 ∆BB moves along BB function with ∆Y
 Discretionary fiscal policies

∆t &/or ∆G  shift BB function  ∆SBB

Shift AE & AD functions & ∆slopes  AE ∆Y
Chapter 7.6
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Automatic and Discretionary Fiscal Policy
26
Discretionary Policy: ∆t or ∆G
∆SBB Shift BB line
BB0 = t0Y – G0
+BB
C
BB2
SBB0
BB1
0
A
B
Y1
-G0
– BB
Chapter 7.6
Yp
Y2
Y
Automatic Stabilization:
∆Y  ∆BB along BB line
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The Public Debt and the Budget Balance
27
Public Debt (PD) ≡ govt bonds issued to finance BB < 0
 The outstanding PD = ∑ (past BB, + & - )
 ΔPD = - BB
 Public Debt Ratio ≡ PD/Y
Chapter 7.7
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Canadian Federal Govt Budget Balances & Public Debt Ratios
1983-2007
28
Chapter 7.7
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Algebra of Income Determination
29
 A general model of Y determination:
Consumption:
Investment:
Govt
Exports
Imports
C = C0 + cYD,
I = I0
G = G0,
X = X0
Z = Z0 + zY
YD = Y – NT
NT = tY
AE = C + I + G + X – Z
= C0 + I0 + G0 + X0 – Z0 + [c(1 – t) – z] Y
= A0 +[c(1 – t) – z] Y
Chapter 7.7
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Algebra of Income Determination
30

Chapter 7.7
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The Multiplier in Canada
31
Y
1
Multiplier 

A 1  c(1  t )  z 
Estimates for Canada:
c(1-t) = 0.54
z = 0.34
The Multiplier for Canada
Y
1
1


 1.25
A 1  0.54  0.34 1  0.2
Chapter 7.8
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AE, AD, & Ye
32
Equil Y = AE
AE = A0 + [c(1 – t) – z]Y
Y = A0/ (1 - c(1 – t) + z)
AE
Equil Y & P: AD = AS
P
Y = AE
A0+[c(1-t)-z]Y
∆Y
A1+[c(1-t)-z]Y
A0
AS
P0
∆A
A1
∆Y
∆Y
AD1
AD0
450
Y1
Y0
Y
Y1
Y0
Y
∆A  Shift AE  ∆Y  Shift AD = ∆Y  ∆Ye @ P0
Chapter 7.8
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Chapter Summary
33
 G is part of autonomous spending (A) in AE & AD.
 Net taxes, NT = tY
NT ↓YD/Y  ↓∆C/∆Y  ↓ slope of AE & ↓ multiplier
 The govt’s Budget Balance BB = NT – G
 Fiscal policy: ∆t &/or ∆G ∆AD  Y = YP
 Structural budget balance: SBB = NT(YP) - G
 ∆SBB indicates ∆discretionary fiscal policy.
Chapter 7
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Chapter Summary
34
 Automatic stabilizers: ↓ ∆Y/∆A the multiplier
 smaller business cycle ∆Y’s .
 Public Debt = ∑ (past BB),
∆PD = – BB
 Public Debt Ratio = PD/Y may limit fiscal policy
 ∆BB < 0 when Y < YP  stabilization & fiscal
stimulus
Chapter 7
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