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24.4 Fiscal Stabilization Policy - Coggle Diagram
24.4 Fiscal Stabilization Policy
Basic Theory
a short run-policy in response to various shocks that cause changes in real GDP by gov. (using fiscal tools)
- ↓tax rates or ↑Gov. purchases or transfers shifts AD curve right = ↑real GDP; used for closing recessionary gaps;
EXPANSIONARY POLICY
- ↑tax rates or ↓Gov. purchases or transfers shifts AD curve to left = ↓real GDP; used for closing inflationary gaps
;
CONTRACTIONARY POLICY
HOWEVER
,
using fiscal policy
in
CLOSING RECESSIONARY GAPS
can
cause inflationary gap
; economy may overshoot its potential output
HOWEVER
,
using fiscal policy in CLOSING INFLATIONARY GAPS
can
cause recessionary gaps;
private-sector expenditures falling for some reason, leads to fiscal contraction being too large and real GDP pushed below potential
Fiscal Policy and Paradox of Thrift
paradox of thrift ~ idea that an increase in desired saving reduces the level of real GDP
during recessions, gov.'s budget can help economy (not just size of organization) so gov. input can reduce paradox of thrift's effects
paradox of thrift applies to AD shifts that have been caused by changes in saving (and spending) behavior → ONLY short run
; in long run AD doesn't affect real GDP, real GDP affected by Y*; ↑S → ↑I → ↑AD
Automatic Fiscal Stabilizers
elements of tax-and-transfer system that reduce real GDP; reduces value of multiplier (↓AD)
Positive AD shock → smaller shift in AD curve THROUGH presence of tax-and-transfer system
Tax-and-transfer system also present in negative AD shock; real GDP ↓, ↓G + net tax revenues → ↓real GDP
Simple Multiplier = 1/(1-z) where z = MPC(1-t)-m
↓net tax rate (t), larger SM implies that a shock to autonomous expenditure would result in a larger shift in the AD curve and thus a larger total change in GDP—that is, the economy would be less stable
even tho ↓net tax rate has its benefits, one drawback is real GDP becoming less stable
Limitations of Discretionary Fiscal Policy
Decision and Execution Lags
decision lag = the period of time b/w perceiving some problem and reaching a decision on what to do about it
; recognition of what type of gap, enactment of legislation, etc.; applies to both tax and expenditure policies
execution lags = time it takes to put policies in place after a decision has been made
; tends to be considerably longer for expenditure than tax policies
by the time fiscal policy is implemented, economical decisions may have changed NO LONGER AFFECTIVE
Fine Tuning vs. Gross Tuning
Fine tuning = maintain output at its potential output by frequent changes of fiscal (and monetary) policy
Gross tuning = use of fiscal and monetary policy to remove large and persistent output gaps
Fiscal Policy and Growth
Increase in Gov. Purchases
addition to short-run boost to GDP will lead to positive impact on Y*; i.e specific changes like gov. purchases towards infrastructure, investment in research, etc.
→ even after factor prices have fully adjusted, economy returns to a higher value of Y*
Reduction in Tax Rates
addition to short-run boost to GDP will lead to positive impact on Y*; i.e reduction in corporate income-tax rates