Suppose that the government reduces spending on healthcare. To which direction does the AD curve shift as a result of falling spending and the following multiplier process?

Sara Albalushi

Outline for Lecture 15

 

Fiscal Policy and the ADAS Model

 

Expansionary Fiscal Policy

 

When a recession occurs, the government may initiate expansionary fiscal policy that is designed to __ increase aggregate demand and therefore raise real GDP__.

 

For a graphical example, suppose that the economy is operating at full employment, as shown by Figure 33.1, producing the potential GDP of $510 at price level P₁.

 

Suppose further that a negative demand shock occurs, shifting the AD curve leftward to AD₂.

 

As a result, output falls from ____ to __ __; price level ____ due to downward price stickiness.

 

There are two expansionary fiscal policy paths to full recovery.

 

1. Increased Government Spending

 

Suppose that the government raises spending on infrastructure. To which direction does the AD curve shift as a result of increased spending and the following multiplier process?

Through the multiplier effect, the aggregate demand curve will shift farther, all the way to AD1, a distance that exceeds the amount represented by the originating $5 billion increase in government purchases.

 

In the final equilibrium, which occurs at the intersection of ___ and ____, output returns to its potential of ___ and price level is ____.

 

2. Tax Reductions

 

Alternatively, suppose that the government cuts taxes on personal income. To which direction does the AD curve shift as a result of falling taxes and the following multiplier process?

the government could reduce taxes to shift the aggregate demand curve rightward from AD2 to AD1.

In the final equilibrium, which occurs at the intersection of ____ and ____, output returns to its potential of ____ and price level is ____.

 

Contractionary Fiscal Policy

 

When demand-pull inflation occurs, a contractionary fiscal policy may help ____.

 

For a graphical example, suppose that the economy is operating at full employment, as shown by Figure 33.2, producing the potential GDP of $510 at price level P₁.

 

Suppose further that a positive demand shock occurs, shifting the AD curve rightward to AD₄.

 

As a result, output rises from ____ to ____; price level rises from ____ to ____.

 

There are two contractionary fiscal policy paths to price stability.

1. Decreased Government Spending

 

Suppose that the government reduces spending on healthcare. To which direction does the AD curve shift as a result of falling spending and the following multiplier process?

 

In the final equilibrium, which occurs at the intersection of ____ and ____, output returns to its potential of ____ while price level ____ due to downward price stickiness.

 

2. Increased Taxes

 

Alternatively, suppose that the government raises taxes on corporate income. To which direction does the AD curve shift as a result of rising taxes and the following multiplier process?

 

In the final equilibrium, which occurs at the intersection of ____ and ____, output returns to its potential of ____ while price level ____ due to downward price stickiness.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Materials for Lecture 15

 

Start with the textbook to get familiar with the content and progression of the lecture. Then, go to videos and supplemental articles, if provided, for further clarification and additional examples.

 

Textbook

 

Read carefully pages 646 through 650 from the textbook.

 

Video

 

Background for fiscal policy analysis

https://www.youtube.com/watch?v=0Cn3mr8RP14&list=PLF2A3693D8481F442&index=25

 

Fiscal policy

https://www.youtube.com/watch?v=1qhJPqyJRo8&list=PLF2A3693D8481F442&index=26

 

Another take on fiscal policy

https://www.youtube.com/watch?v=oGQBvDt3BqI

 

Article

 

Public policy after the Great Recession

https://cepr.org/voxeu/columns/why-global-recovery-different

 

Tax rates in the U.S.

https://www.nytimes.com/interactive/2019/10/06/opinion/income-tax-rate-wealthy.html

Outline for Lecture 16

 

Recent and Projected U.S. Fiscal Policy

 

The budget balance in a given year, surplus or deficit, is determined by the levels of government spending and tax collections in that year.

 

For example, if government spending exceeds tax collections, the government is said to run a budget ____.

 

By contrast, if tax collections exceed government spending, the government is said to run a budget ____.

 

The second column of Table 33.1 reports the actual budget deficits/surpluses for the U.S. federal government as percentage of GDP for the period from 2000 to 2018.

 

What was the budget balance in 2000? How about 2001? What does the positive sign indicate?

 

Report the budget balances for remaining years. What does the negative sign indicate?

 

Why do we observe a large increase in deficits during the late 2000s? Explain.

 

Problems, Criticisms, and Complications

 

Problems of Timing

 

Recognition lag

 

How do we define the recognition lag? Provide an example.

 

What is the impact of the recognition lag on the severity of an economic problem? Explain in your example.

 

Administrative lag

 

How do we define the administrative lag? Provide an example.

 

What is the impact of the administrative lag on the severity of an economic problem? Explain in your example.

 

Operational lag

 

How do we define the operational lag? Provide an example.

 

How do operational lags compare in taxation versus government spending? Explain.

 

The U.S. Public Debt

 

How do we define the national (public) debt?

 

How does a budget deficit affect public debt: raise it or reduce it? How about a budget surplus?

 

Ownership

 

Figure 33.5 illustrates the ownership shares in the U.S. debt of $21.5 trillion in 2018.

 

What is the share held by the U.S. government agencies? How about the Federal Reserve?

 

What is the share held by foreign entities? Which foreign nations hold the largest amount of the U.S. debt?

 

The U.S. debt is large. So is the size of the U.S. economy. Therefore, a better measure of public indebtedness is the ratio of debt to GDP.

 

Figure 33.6 shows the U.S. debt held by public (outside of federal government) as percentage of GDP since the 1970s.

 

The debt/GDP ratio fluctuated between a low of ____ observed in ____ and a high of ____ observed in ____.

 

Why do we observe a large increase in the debt/GDP ratio during the late 2000s? Explain.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Materials for Lecture 16

 

Start with the textbook to get familiar with the content and progression of the lecture. Then, go to videos and supplemental articles, if provided, for further clarification and additional examples.

 

Textbook

 

Read carefully pages 654 through 659 from the textbook.

 

Video

 

Government spending, taxes, budget, and debt in first two minutes

https://www.youtube.com/watch?v=lafDykKJ_9I&list=PLF2A3693D8481F442&index=28

 

Problems of timing (different terminology) after three-minute mark

https://www.youtube.com/watch?v=RGlt0nEQdRI&list=PLF2A3693D8481F442&index=27

 

Another take on budget and debt

https://www.youtube.com/watch?v=Thzg9F7mi0E&index=5&list=PLD36AFEC0D8191A04

 

Article

 

Recent data from Congressional Budget Office

https://www.cbo.gov/topics/budget

 

Public debt over time

https://cepr.org/voxeu/columns/public-debt-through-ages