Transcript Macroeconomics James B. Wilcox

Macroeconomics
James B. Wilcox
RESOURCES PROVIDED BY:
THE UNIVERSITY OF SOUTHERN MISSISSIPPI
CENTER FOR ECONOMIC AND ENTREPRENEURSHIP
EDUCATION,
MISSISSIPPI STATE UNIVERSITY, & VIRTUAL
ECONOMICS
Economics…
is the study of how individuals and society choose,
with or without the use of money, to employ scarce
productive resources to produce various
commodities over time and distribute them for
consumption, now and in the future, among various
people and groups in a society.
Introduction to Macroeconomics
3
Macroeconomics
4
 Macro is the study of:
 The structure and performance of a national economy
 4 important variables:
 1. GDP


2. P


the price level
3. UNE


Gross Domestic Product
national unemployment rate
4. r

interest rate
U.S. Macro Economy
5
 Very complicated
 95 million households
 20 million firms
 80 thousand governments
Macro Terms
6
 Stock:
 A quantity at a point in time
 Flow:
 A quantity during a period of time
Macro Terms
7
 GDP, (Y) Gross Domestic Product:
 Value of total production of all final goods and services during
a period of time
 Flow variable
 Potential GDP (YN):
 The economy’s maximum sustainable output when resources
are allocated efficiently
 not over-utilized nor under-utilized
Macro Terms
8
 Unemployment types
 Frictional – voluntary unemployment that arises because of
the time needed to match job seekers with job openings
 Structural – unemployment caused by massive mismatch of
skills or geographic location
 Seasonal – unemployment caused by seasonal changes in labor
supply and demand during the year
 Cyclical – unemployment that is incurred by business cycles,
or more specifically by economic recessions
GDP
Final Outputs
9
 GDP consists of only:
 Final goods and services
 GDP does not include:
 1. Intermediate outputs in order to avoid over-counting


2. Used goods


Intermediate outputs are used as inputs to make final outputs e.g. capital
goods
they were counted the first time they were purchased
3. Financial assets

e.g. stocks, bonds
Which of the following is an example of an intermediate
good?
10
A pair of jeans sold by a clothing retailer
B. Cloth sold to a suit manufacturer
C. A share of Wal-Mart stock
D. A used Ford Mustang sold from one neighbor
to another
A.
Which of the following is an example of an intermediate
good?
11
A pair of jeans sold by a clothing retailer
B. Cloth sold to a suit manufacturer
C. A share of Wal-Mart stock
D. A used Ford Mustang sold from one neighbor
to another
A.
Limitations of Real GDP
12
 Real GDP is used to:
 Estimate the speed at which the economy is moving
 Does not count:
 Non-market activities

Things that are not priced
 E.g., Household production, underground economy
If individuals were paid for their household production,
GDP would
13
increase
B. decrease
C. Not change
D. Not enough information
A.
If individuals were paid for their household production,
GDP would
14
increase
B. decrease
C. Not change
D. Not enough information
A.
Limitations of Real GDP
15
 GDP is not a perfect measure of the welfare of a
nation:
 It does not include measures of:



Quality of life
Leisure time
Conditions of environment
Limitations of Real GDP
16
 Robert Kennedy 1968 Presidential bid:
 “[GDP] does not allow for the health of our children, the quality of their
education, or the joy of their play. It does not include the beauty of our
poetry or the strength of our marriages, the intelligence of our public
debate or the integrity of our public officials. It measures neither our
courage, nor our wisdom, nor our devotion to our country. It measures
everything, in short, except that which makes life worthwhile, and it
can tell us everything about America except why we are proud that we
are Americans.”
Limitations of Real GDP
17
 GDP doesn’t measure many things, but nations with greater
GDP can afford……



better health care for their children
better educational system
to teach more people to read and enjoy poetry
 Intelligence, integrity, courage, wisdom, devotion to
country are easier to foster when people are less concerned
about affording basic necessities.
 We conclude that

GDP is a good measure of welfare for most, but not all, purposes
GDP and Standard of Living
18
 International data leave no doubt that a nation’s
GDP is closely associated with its citizens’ standard
of living
 Use per capita GDP when comparing across nations
 Per capita GDP = GDP/population
19
Country
life expectancy
U.S.
RealGDP per
person (1993)
$24,680
76 years
adult
literacy
99%
Japan
20,660
80
99
Germany
18,840
76
99
Mexico
7,010
71
89
Brazil
5,500
67
82
Russia
4,760
67
99
Indonesia
3,270
63
83
China
2,330
69
80
Pakistan
2,160
62
36
Nigeria
1,540
51
54
Bangladesh
1,290
56
37
India
1,240
61
51
GDP = AE = AI
20
 Aggregate Expenditures (AE):
 The total amount that buyers pay for the final goods and services
produced
 Everything a firm receives from the sale of its output is paid
out as income to the resource owner (AI):




Wages go to labor owners
Rent goes to land owners
Interest goes to capital owners
Profit goes to owners of entrepreneurial ability
GDP = AE = AI
21
 The buyers of GDP
 pay an amount equal to aggregate expenditures (AE)
 The sellers of GDP
 receive an amount equal to aggregate income (AI)
 Therefore,
 GDP = AE = AI
 For an economy as a whole
 Income must equal expenditure
 For every transaction there is a buyer and a seller
Calculating Real GDP
22
 3 ways to calculate GDP:
 1. Expenditure approach
 2. Factor Income approach
 3. Value Added approach
 We will use the expenditure approach
 GDP = C + I + G + NX




C, personal consumption expenditure
I, gross private investment expenditure
G, government expenditure
NX, net export expenditure
Consumption Expenditure, C
23
 Consumption, C
 Spending by households on new goods and services, with the
exception of new housing
 e.g. Purchases of food, clothing, services, autos, other durable
goods like furniture
Gross Investment Expenditure, I
24
 Investment, I
 Spending on capital equipment, inventories, and structures including
household purchases of new housing
 Nonresidential investment


Residential investment


E.g. machinery, equipment, factories, warehouses, offices purchased by
firms
purchases of newly built homes
Inventory change

firms’ accumulation of their output
25
Which of the following is NOT included in the
investment category under the expenditure
approach to GDP accounting?
Newly constructed residential housing
B. Factory buildings
C. Stocks and bonds
D. Additions to inventory
E. All of the above are included in investment
A.
26
Which of the following is NOT included in the
investment category under the expenditure
approach to GDP accounting?
Newly constructed residential housing
B. Factory buildings
C. Stocks and bonds
D. Additions to inventory
E. All of the above are included in investment
A.
Residential construction is generally included in which
category of GDP?
27
consumption
B. investment
C. Government expenditures
D. Net exports
A.
Residential construction is generally included in which
category of GDP?
28
consumption
B. investment
C. Government expenditures
D. Net exports
A.
Government Expenditure, G
29
 Government, G
 Spending on goods and services by local, state, and federal
governments


E.g., salaries, computers, military hardware, etc.
Does NOT include transfer payments like social security,
welfare, etc.
Government purchases include all of the following
except:
30
Welfare payments
B. Salaries of senators
C. Fighter jets purchased by the government
D. The military payroll
A.
Government purchases include all of the following
except:
31
Welfare payments
B. Salaries of senators
C. Fighter jets purchased by the government
D. The military payroll
A.
Net Export Expenditure, NX
32
 Net Exports, NX
 Spending by foreigners on domestically produced goods (exports)
minus spending by domestic residents on foreign goods (imports)
 Net Exports (NX)= Exports (X)- Imports (M)
 If M > X =>
 NX are negative,
 I.e. trade deficit

Americans spent more on foreign goods and services than foreigners
spent on American goods and services
Net Export Expenditure, NX
33
 Purchases of foreign goods and services are
 included in C, I, G

E.g. American spending on a Volvo (Swedish car) is included in C
 We minus imports because
 we are trying to get a measure of domestic activity
Net exports are defined as
34
Exports plus imports
B. Exports minus imports
C. Imports minus exports
D. Exports plus imports minus tariffs
A.
Net exports are defined as
35
Exports plus imports
B. Exports minus imports
C. Imports minus exports
D. Exports plus imports minus tariffs
A.
36
Consumption is the largest single component of
GDP. In recent years it represents approximately
_____ % of GDP.
55
B. 60
C. 65
D. 70
E. 75
A.
37
Consumption is the largest single component of
GDP. In recent years it represents approximately
_____ % of GDP.
55
B. 60
C. 65
D. 70
E. 75
A.
GDP Components
38
GDP Estimates
39
 Estimates are constantly
 being revised
 Advance estimates:
 released 15 days after the quarter ends and are based on only the first
month of the quarter
 Preliminary estimates:
 first revision, 45 days after the end of the quarter
 Final estimates:
 second revision, 75 days after the end of the quarter
GDP Estimates
40
 Annual estimates:
 numbers are then revised once a year for two years
 Benchmark estimates:
 revisions made every 5 years
GDP Estimates
41
 The media focuses on:
 Advance estimates
 Range of revisions can result in changes
 ranging from –2.5 % points to +3.5% points from advance
estimates until benchmark estimates
GDP Estimates
42
 If advance estimates show a 3% annualized growth
rate in real GDP, find the range of actual real GDP
once all revisions are made:

Lower bound:


3% - 2.5% = .5% actual annualized growth rate
Upper bound:

3% + 3.5% = 6.5% actual annualized growth rate
 Serious implications for
 policy makers
Saving, Investment, and
Financial Intermediaries
43
Making
the
Connection
Learning Objective 21.2
Ebenezer Scrooge: Accidental
Promoter of Economic Growth?
44
Who was better for economic growth: Scrooge the
saver or Scrooge the spender?
Who was better for the economy?
45
Scrooge the saver
B. Scrooge the spender
A.
Who was better for the economy?
46
A.
Scrooge the saver
best for long run economic growth
B.
Scrooge the spender
best if we are in a recession
“Saving”
47
When a person earns more than he spends

Individuals can deposit the unspent income into a bank, or buy
a bond or some stock
Individuals often refer to this activity as “investing”

However, macroeconomists call this “saving”
U.S. vs Japanese savings rates
“Investment”
48
Investment

Purchase of new capital

Equipment or buildings
Examples of investment


An individual who borrows to finance building a new house
A firm sells some stock to build a new factory
S=I
49
For the macroeconomy as a whole

Saving (S) must equal investment (I)
Recall that GDP equals

Y = C + I + G + NX
Assume the economy is closed so that NX = 0
Y=C+I+G
 Each unit of output sold in a closed economy is
consumed, invested, or bought by the government

S=I
50
To emphasize the link between saving and
investment,

subtract C and G from both sides
You get,

Y–C-G=I
Y – C – G is
the total income in the economy that remains after
paying for consumption and government purchases
 i.e., national saving, S

Which leaves,

S=I
Financial Institutions
51
The financial system is made up of institutions that

Coordinate individuals who are saving and individuals
who are investing
Savers supply their money to the financial system

With the expectation of earning interest
Borrowers demand funds from the financial system

Knowing they will be required to pay it back with interest
Financial Markets
Bond Market
52
Bond

Promise to pay back a loan
Large corporations can borrow money directly from
the public by selling bonds
The person who buys the bond gives money to the firm
 Firm uses the funds to expand their business
 This is called debt financing

The buyer can either
hold the bond until maturity
 can sell the bond to someone else

Financial Markets
Stock Market
53
Stock

Represents ownership in a firm
Stockholders own the company
Thus, they own the profits or losses
 Stocks are riskier than bonds
 Pay a higher rate of return

Firms can sell stock in order to raise funds to expand

This is called equity financing
Financial Markets
Stock Market
54
After the firm issues the stock

The shares are traded on organized stock exchanges


NYSE, NASDAQ, AMSE
Corporations themselves do not earn anything from the
trades
Prices of stocks are determined by
the demand and supply for each one
 Reflects the beliefs about the value of a company

Stock index

A computed average of a group of stock prices
Dow Jones Industrial Average--30 major U.S. companies
 Standard and Poor’s—500 major companies

Financial Intermediaries
Banks
55
In order to borrow funds, most firms must use
banks
 Only the largest and most widely recognized firms can
borrow funds through bonds and stocks

Banks
Take deposits from people who are saving and pay them
an interest rate
 Give loans to those who are borrowing and charge them
an interest rate
 The difference in the interest rate paid out and charged
provides profits to the bank owners

Financial Intermediaries
Mutual Funds
56
Mutual Fund
An institution that sells shares to the public and buys a
portfolio of stocks and bonds
 Many different types of stocks and bonds

Enables savers to

Diversify


Lowering risk
Receive services of professional money managers
Index fund

A fund that buys all the stocks in a given stock index
Market for Loanable Funds
57
Because the economy has many types of financial
institutions
There are many different interest rates
 All are determined through the demand and supply of
funds

Assume for simplicity that there is just one market
for loanable funds
All savers go to this market to deposit saving
 All borrows go to this market in order to invest

Supply of Loanable Funds
58
The source of the supply of loanable funds is

Saving
At higher interest rates


Saving is more attractive
The quantity saved increases
At lower interest rates


Saving is less attractive
The quantity saved decreases
Demand for Loanable Funds
59
The source of the demand of loanable funds is
Borrowing
 I.e., investment

At higher interest rates
borrowing is less attractive
 The quantity borrowed and invested decreases

At lower interest rates
borrowing is more attractive
 The quantity borrowed and invested increases

Equilibrium
Real Interest Rate, rr*
60
The equilibrium real interest rate occurs

where the supply and demand for loanable funds
intersects
If the interest rate were lower than rr*
There would be a shortage of loanable funds
 Lenders would be scarce and borrowers plentiful
 Increasing the interest rate

If the interest rate were higher than rr*
There would be a surplus of loanable funds
 Lenders would be plentiful and borrowers would be
scarce
 Decreasing the interest rate

Invisible Hand
61
Financial markets

work much like other markets
In this case



Saving represents the supply of loanable funds
Investment represents the demand for loanable funds
Interest rate adjust to balance the supply and demand in the
market for loanable funds
Government Policy to
Increase Saving
62
Taxes on saving

Lower saving for every given interest rate
If the government decided to reduce taxes on saving

The incentive to save would increase for every given interest
rate
1. Increase the supply of saving curve
 2. Reduce the equilibrium interest rate
 3. Increase the level of investment

Government Policy to
Increase Investment
63
Giving firms an investment tax credit would

Encourage more firms to borrow and invest in new capital
for every given interest rate



1. Increase the demand for investment
2. Increase the interest rate
3. Increase the amount of saving
Inflation
64
Macro Terms
65
 Average (Aggregate) Price Level, P:
 The average price of all outputs
 Absolute concept, not relative
 Inflation:
 Process of rising prices
 Nominal:
 NOT adjusted for inflation
 “current dollars”
 Real:
 Adjusted for inflation
 “constant dollars”
Macro Terms
66
 Hyperinflation:
 Inflation that exceeds 50% a month
 Deflation:
 Process of falling prices
 Disinflation:
 Slowing of inflation
Real v. Nominal GDP
67
 Nominal GDP:


GDP valued in current dollars
not adjusted for inflation
 Real GDP:


GDP valued in constant dollars
adjusted for inflation


More informative than nominal
often compared across time
Business Cycles
68
Macro Terms
69
 Business Cycle:
 Shows fluctuations in GDP around potential GDP
 Recession:
 Real GDP decreases for at least two successive quarters
 associated with rising unemployment, falling profits and
income
 Depression:
 Extremely severe decline in real GDP
 Expansion:
 Rising real GDP
 associated with falling unemployment, higher profits and
income
The Business Cycle
70
REAL GDP
Peak
Expansion
Recession
Trough
TIME
Y and YN
71
GDP
Actual Real GDP and Potential Real GDP
9000
8000
7000
6000
5000
4000
3000
2000
1000
0
Year
What We Learn From GDP
72
 By looking at the graph, we learn that:
 1. real GDP grows over time


output of goods and services has grown over time averaging about
3% per year
allows the typical American to enjoy greater prosperity than
his/her parents and grandparents
 2. growth is not steady

upward climb is occasionally interrupted by periods of decline
 Macroeconomics is about explaining both--the long-
run trends and the short-run fluctuations
73
http://www.econedlink.org/
Activity 17
74
75
Money and Monetary Policy
76
FEDERAL RESERVE SYSTEM
TOOLS OF THE FED
EXPANSIONARY MONETARY POLICY
CONTRACTIONARY MONETARY POLICY
POLICY DEBATES
The Federal Reserve was established in 1913 to
77
Prevent inflation by decreasing the money
supply
B. Stimulate the economy by increasing bank
reserves
C. Stop bank panics by acting as a lender of last
resort
D. Prevent bad loans by requiring banks to hold
reserves
A.
The Federal Reserve was established in 1913 to
78
Prevent inflation by decreasing the money
supply
B. Stimulate the economy by increasing bank
reserves
C. Stop bank panics by acting as a lender of last
resort
D. Prevent bad loans by requiring banks to hold
reserves
A.
Which of the following is not a function of the
“Fed”?
79
Acting as lender of last resort
B. Acting as a banker’s bank
C. Performing check clearing services
D. Insuring deposits in the banking system
E. Taking actions to control the money supply
A.
Which of the following is not a function of the
“Fed”?
80
Acting as lender of last resort
B. Acting as a banker’s bank
C. Performing check clearing services
D. Insuring deposits in the banking system
E. Taking actions to control the money supply
A.
Federal Reserve System
81
 The Fed
 Is a special kind of bank


a bank for banks
The Fed acts as a central banking system with centralized
economic power
 The Fed’s job:
 Is to manage the money supply in what it perceives to be the
national interest
Federal Reserve System
82
 Fed was established in 1913
 Very recent
 Federal Reserve System is made up of
 12 central banks, each with its own region
 The Fed is run by a 7 member Board of Governors
 Appointed by the President and confirmed by the Senate
 14 year terms
 President designates a chairman for a 4 year term
 Headquartered in Washington, D. C.
Federal Reserve System
83
 Once appointed, the governors are
 independent of the rest of government
 This is to give the Fed the ability
 to make decisions on objective, technical criteria
 rather than on political agendas
FOMC
84
 Federal Open Market Committee, FOMC:
 Works with the Board of Governors and largely
determines the size of the U.S. money supply
 FOMC has 12 members:
 7 governors
 5 presidents of district banks
 FOMC meets every
 six weeks
 Policy implementation is normally done through
 the New York Fed Bank
Money
85
Liquidity
86
 Liquidity
 The ease of an asset’s ability to be converted to cash
 An asset is completely “liquid” if
 one can spend it now
Definitions of the Money Supply
87
 There are 3 measures of the money supply
 M1

The most liquid of all definitions of the money supply
M2
 M3

 Currency held by banks in the form of reserves
 is NOT counted as part of the money supply
 because it is not available for individuals to make
purchases with
Definitions of the Money Supply
88
 M1=
 Sum of all currency, coin, traveler’s checks in the hands of the
public


30%
Sum of all of the most liquid checking accounts

70%
 M2=
 M1 + savings accounts, money market mutual funds, small
time deposits (cd’s < 100,000)
 M3=
 M1 + M2 + large time deposits
Which of the following assets is most liquid?
89
money
B. bond
C. savings account
D. stock
A.
Which of the following assets is most liquid?
90
money
B. bond
C. savings account
D. stock
A.
Money Creation Process
91
Banks hold 100% of their checking deposits as vault cash
to ensure that bank runs do not occur.
92
True
B. False
A.
Banks hold 100% of their checking deposits as vault cash
to ensure that bank runs do not occur.
93
True
B. False
A.
Money Creation Process
94
 Fractional Reserve Banking System:
 Banks keep only part of all its deposits
 When a bank gets a new deposit:
 it keeps a portion of it in reserves and then lends out the
rest
 Individuals and firms receiving the loans then deposit
their loan checks into their banks
 Those banks:
 repeat the process by keeping a portion of the deposit and
then lending out the rest
 Hence, a fractional reserve system creates money
 i.e., increases the money supply
Which of the following best describes how
banks create money?
95
Banks charge higher interest rates on loans
than they pay on deposits
B. Banks charge fees for providing financial advice
C. Banks create checking account deposits when
making loans from excess reserves
D. Banks make loans from reserves
A.
Which of the following best describes how
banks create money?
96
Banks charge higher interest rates on loans
than they pay on deposits
B. Banks charge fees for providing financial advice
C. Banks create checking account deposits when
making loans from excess reserves
D. Banks make loans from reserves
A.
Tools of the Federal Reserve
97
The Fed directly controls the interest rate and
inflation rate.
98
True
B. False
A.
The Fed directly controls the interest rate and
inflation rate.
99
True
B. False
A.
Tools of the Fed
100
 The Fed uses 3 tools to control the money supply
 1. Open market operations
 2. Required reserve ratio
 3. Discount rate
RRR
101
 The Fed
 sets the RRR
 If the Fed increases the RRR
 Banks are required to hold more of their deposits
 decreasing the money supply
 If the Fed decreases the RRR
 Banks are free to lend out more of their deposits
 increasing the money supply
Discount Rate
102
 Discount Rate
 the interest rate that individual banks pay to the Fed in
order to borrow funds
 If the Fed increases the discount rate
 It is more expensive to borrow from the Fed
 banks tend to hold more excess reserves
 decreasing the money supply
 If the Fed decreases the discount rate
 It is less expensive to borrow from the Fed
 banks tend to hold fewer excess reserves
 increasing the money supply
OMO
103
 Open Market
 financial marketplace made up of non-government sectors
 If the Fed sells government securities:
 Individuals and firms begin to buy them from the Fed
 Money goes from the open market (in the Ms) to the Fed (out
of the Ms)
 The money supply falls
 If the Fed buys government securities:
 Individuals and firms begin to sell them to the Fed
 Money goes from the Fed (out of the Ms) to the open market
(in of the Ms)
 The money supply increases
The three main monetary policy tools used by the Fed to
manage the money supply are
104
Interest rates, tax rates, and government
spending
B. Tax rates, government purchases, and transfer
payments
C. Open market operations, discount policy, and
reserve requirements
D. Open market operations, the exchange rate,
and government purchases
A.
The three main monetary policy tools used by the Fed to
manage the money supply are
105
Interest rates, tax rates, and government
spending
B. Tax rates, government purchases, and transfer
payments
C. Open market operations, discount policy, and
reserve requirements
D. Open market operations, the exchange rate,
and government purchases
A.
Expansionary Monetary Policy
106
 The Fed can increase the Ms by doing the following
 Buying government bonds
 Decreasing the RRR
 Decreasing the discount rate

M


r
r
*


I


G
D
P
s
Contractionary Monetary Policy
107
 The Fed can decrease the Ms by doing the following
 Selling government bonds
 Increasing the RRR
 Increasing the discount rate

M


r
r
*


I


G
D
P
s
Expansionary monetary policy refers to the
_____ to increase real GDP.
108
Government’s increasing spending and
lowering taxes
B. Government’s decreasing spending and raising
taxes
C. Federal Reserve’s increasing the money supply
and decreasing interest rates
D. Federal Reserve’s decreasing the money supply
and increasing interest rates
A.
Expansionary monetary policy refers to the
_____ to increase real GDP.
109
Government’s increasing spending and
lowering taxes
B. Government’s decreasing spending and raising
taxes
C. Federal Reserve’s increasing the money supply
and decreasing interest rates
D. Federal Reserve’s decreasing the money supply
and increasing interest rates
A.
Which of the following is true about the Fed’s ability
to prevent recessions? The Fed
110
Does not try to eliminate recessions, but
instead focuses on preventing inflation
B. Can fine tune the economy and realistically
hope to keep the economy from
experiencing recessions
C. Cannot realistically fine tune the economy,
but seeks to keep recessions shorter and
milder than they would otherwise be
D. Cannot realistically fine tune the economy
and has little to no effect on the magnitude
and length of recessions
A.
Which of the following is true about the Fed’s ability
to prevent recessions? The Fed
111
Does not try to eliminate recessions, but
instead focuses on preventing inflation
B. Can fine tune the economy and realistically
hope to keep the economy from
experiencing recessions
C. Cannot realistically fine tune the economy,
but seeks to keep recessions shorter and
milder than they would otherwise be
D. Cannot realistically fine tune the economy
and has little to no effect on the magnitude
and length of recessions
A.
Should Policymakers Try to
Stabilize the Economy?
112
Yes, Policymakers Should Stabilize
113
 Argument:
 Economies fluctuate on their own and there is no reason
to suffer through booms and busts
 Recession lead to lower real GDP and higher
unemployment
 Expansions lead to higher inflation
 During a recession policymakers should
 Increase government spending, cut taxes, and expand the
money supply
 During an expansion policymakers should
 Decrease government spending, raise taxes, and decrease
the money supply
No, Policymakers Should Not Stabilize
114
 Argument:
 Allow the economy to heal itself and “do no harm”
 Substantial obstacles to the effective use of policy
changes to influence the economy
Time lags can be anywhere from 6 months to several
years
 Policymakers need accurate information on the future of
the economy to make accurate policy changes



Economic forecasts are imprecise
Policy changes can make matters worse
115
http://www.econedlink.org/
Fiscal Policy
116
FISCAL POLICY AND DEMAND
SUPPLY-SIDE ECONOMICS
Fiscal Policy
117
Fiscal Policy

The use of the federal budget to achieve macro goals
full employment
 sustained economic growth
 price level stability

This use of fiscal policy came

after the Great Depression of the 1930’s and the thinking
of John Maynard Keynes
Prior to that,
governments allowed the economy to regulate itself
 the federal budget was used only to finance the activities
of the federal government

Tools of Fiscal Policy
118
3 tools of fiscal policy
G
 Taxes
 Transfers

To analyze each one

Hold everything else constant
Changes in G
Expansionary
 Contractionary


G

GDP

G

GDP
Fiscal Policy and AD
119
Changes in Taxes



DI = Income – taxes + transfers
Expansionary

taxe


DI


C


G
Contractionary
Changes in Transfers


Expansionary
Contractionary

taxe


DI


C


G

tran


DI


C


G

tran


DI


C


G
Learning Objective 15.2
The Effects of Fiscal Policy
on Real GDP and the Price Level
120
Table 15-1
Countercyclical Fiscal Policy
ACTIONS BY
CONGRESS AND THE
PRESIDENT
RESULT
PROBLEM
TYPE OF
POLICY
Recession
Expansionary
Increase government
spending or cut taxes
Real GDP and the
price level rise.
Rising Inflation
Contractionary
Decrease government
spending or raise taxes
Real GDP and the
price level fall.
Don’t Let This Happen to YOU!
Don’t Confuse Fiscal Policy and Monetary Policy
An increase in individual income taxes _____ disposable
income, which _____ consumption spending.
121
Increases; increases
B. Increases; decreases
C. Decreases; increases
D. Decreases; decreases
A.
An increase in individual income taxes _____ disposable
income, which _____ consumption spending.
122
Increases; increases
B. Increases; decreases
C. Decreases; increases
D. Decreases; decreases
A.
If the economy is falling below potential real GDP, which of
the following would be an appropriate fiscal policy? An
increase in
123
The money supply and a decrease in interest
rates
B. Government purchases
C. Oil prices
D. Taxes
A.
If the economy is falling below potential real GDP, which of
the following would be an appropriate fiscal policy? An
increase in
124
The money supply and a decrease in interest
rates
B. Government purchases
C. Oil prices
D. Taxes
A.
If real GDP exceeded potential real GDP and inflation was
increasing, which of the following would be an appropriate fiscal
policy?
125
A decrease in the money supply and an
increase in the interest rate
B. An increase in government spending
C. An increase in taxes
D. An increase in oil prices
A.
If real GDP exceeded potential real GDP and inflation was
increasing, which of the following would be an appropriate fiscal
policy?
126
A decrease in the money supply and an
increase in the interest rate
B. An increase in government spending
C. An increase in taxes
D. An increase in oil prices
A.
Fiscal Policy and
Aggregate Supply
127
Fiscal Policy and
Aggregate Supply
128
“Supply-side economics”

Attempts to increase YN, potential real GDP
Taxes create

Disincentives which decrease potential real GDP
So, lower income taxes


Strengthens the incentive to work
Increases aggregate supply
Marginal Tax Rates
129
Marginal tax rates of the richest Americans:





Carter
Reagan
Bush
Clinton
W. Bush
50%
28%
31%
39.6%
35%
Fiscal Policy and
Aggregate Supply
130
Tax policies encouraging I


Lead to higher stocks of capital
Increases aggregate supply
Tax relief for firms in R & D


Encourage new technology
Increases aggregate supply
Supply-Side Economics and Aggregate Demand
131
However, lowering taxes and increasing investment

Also increase AD

taxes


DI

C

GD

I

GDP
Supply-Side Economics
132
Supply-side is largely effective in the SR

because of its effects on Aggregate Demand
Supply-side economics is largely effective in the LR

because of its effects on Aggregate Supply
Which of the following would be classified as
fiscal policy?
133
The federal government passes tax cuts to
encourage firms to reduce air pollution
B. The Federal Reserve cuts interest rates to
stimulate the economy
C. A state government cuts taxes to help the economy
of the state
D. The federal government cuts taxes to stimulate the
economy
A.
Which of the following would be classified as
fiscal policy?
134
The federal government passes tax cuts to
encourage firms to reduce air pollution
B. The Federal Reserve cuts interest rates to
stimulate the economy
C. A state government cuts taxes to help the economy
of the state
D. The federal government cuts taxes to stimulate the
economy
A.
Which of the following best describes supply-side
economics?
135
Labor productivity impacts aggregate supply
B. Education impacts labor productivity which
impacts aggregate supply
C. Education impacts the incentive to work, save,
and invest, and therefore aggregate supply
D. Tax rates, particularly marginal tax rates, affect
the incentive to work, save, and invest, and
therefore aggregate supply
A.
Which of the following best describes supply-side
economics?
136
Labor productivity impacts aggregate supply
B. Education impacts labor productivity which
impacts aggregate supply
C. Education impacts the incentive to work, save,
and invest, and therefore aggregate supply
D. Tax rates, particularly marginal tax rates, affect
the incentive to work, save, and invest, and
therefore aggregate supply
A.
Activities 30 / 31
137
138
139
140
Should We Worry About the National
Debt?
141
If we took all of our nation’s income and paid off the
national debt, how long will it take?
More than 10 years
B. Five years
C. Two years
D. One year
E. Less than one year
A.
If we took all of our nation’s income and paid off the
national debt, how long will it take?
More than 10 years
B. Five years
C. Two years
D. One year
E. Less than one year
A.
Federal Budget
144
 Deficit/Surplus
 Revenues > Expenditures


surplus
Expenditures > Revenues

deficit
 A deficit (or surplus) is a
 flow variable
 Debt is a
 stock variable
 Government debt is sold by issuing bonds
 Treasury “T” bills to the public
Learning Objective 15.5
The Federal Budget Deficit
145
FIGURE 15.13
The Federal Budget Deficit,
1901–2006
Reasons NOT to worry
about the debt
146
The following work to “reduce” the figures


1. Take figures in relation to GDP
2. Adjust for state and local surpluses and debt owned
by government



3. Adjust for the cyclical component of the economy
4. Adjusting for capital outlays


“Net public debt”
It is normal for capital outlays to grow in a growing economy
5. Adjusting for inflation
Learning Objective 15.5
Federal Government Debt
147
Current Debt
148
The current debt is $11.9 trillion dollars
$4.4 trillion is held by government agencies

Therefore, the U.S. net public debt is about


$7.6 trillion
Nominal GDP is about

$14.2 trillion
In other words, net public debt makes up

53.5% of GDP
If we used all of the nation’s resources to pay off the debt
alone, how long would it take to pay it off?

About 7 months
Should we worry about the debt?
149
The cause of the debt

is important to whether it is a burden
Until the 1980’s most debt was acquired because of
war or recession
 These are taken to be good reasons to incur debt

1980’s and 1990’s and early 2000s have seen
rising structural deficits due to expansionary policy
 Cause for concern for incurring debt

Reasons TO worry about the debt
150


1. The ensuing inflation
2. Effects on Investment
A deficit is negative saving
 Supply of national saving decreases
 Increasing the interest rate
 Some private investment is “crowded out”
 The “I” in GDP
 Leads to lower capital stock, K, in the future
 Lower productivity and standard of living

Reasons TO worry about the debt
151

3. Borrowing from abroad
About 40% of net public debt is held by foreigners
 The higher interest rates encourage more investment in the U.S.
by foreigners
 The higher interest rates cause the dollar to appreciate
 Twin deficits


4. Growth of interest payments

Opportunity cost
Should the Federal Government Have a
Yearly Balanced Budget?
152
State of the Economy on Deficits
153
Larger deficits

do not always mean the government has undertaken
expansionary fiscal policy
The same fiscal policies can lead to

large or small deficits depending on the state of the economy
With no change in policy:


Recessions increase deficits
Expansions decrease deficits
State of the Economy on Deficits
154
Recessionary Gap



Tax revenues fall
Transfer payments rise
=>Deficits increase
Under a yearly balanced budget, gov’t expenditures
must:

Decrease, making the gap worse
State of the Economy on Deficits
155
Expansionary Gap



Tax revenues rise
Transfer payments fall
=>Deficits decrease
Under a yearly balanced budget, gov’t expenditures
must:


Increase, making the gap worse
“boom the boom”
State of the Economy on Deficits
156
Economists prefer using the

structural deficit rather than the actual deficit
Structural deficit
is based on what expenditures would be if the economy
were at full employment
 changes as policy changes, not as the economy changes

If the goal is a balanced budget

The structural deficit should be balanced over the
business cycle
A recession tends to cause the federal budget deficit to _____ b/c
tax revenues _____ and government spending on transfer
payments _____.
157
Increase; rise; fall
B. Increase; fall; rise
C. Decrease; rise; fall
D. Decrease; fall; rise
A.
A recession tends to cause the federal budget deficit to _____ b/c
tax revenues _____ and government spending on transfer
payments _____.
158
Increase; rise; fall
B. Increase; fall; rise
C. Decrease; rise; fall
D. Decrease; fall; rise
A.
Macroeconomics
James B. Wilcox
RESOURCES PROVIDED BY:
THE UNIVERSITY OF SOUTHERN MISSISSIPPI
CENTER FOR ECONOMIC AND ENTREPRENEURSHIP
EDUCATION,
MISSISSIPPI STATE UNIVERSITY, & VIRTUAL ECONOMICS