Fiscal Policy

2012

Copyright  2004 McGraw-Hill Australia Pty Ltd

PPTs t/a Macroeconomics 7/e by Jackson and McIver 9-1
Slides prepared by Muni Perumal, University of Canberra, Australia
Learning Objectives
• Discuss the implications of and
complications associated with fiscal policy
within the aggregate demand–aggregate
supply framework

Copyright  2004 McGraw-Hill Australia Pty Ltd

PPTs t/a Macroeconomics 7/e by Jackson and McIver 9-2
Slides prepared by Muni Perumal, University of Canberra, Australia
Federal Government
Finance
• Federal expenditures
– large expenditure on social security and welfare
– specific purpose grants

• Federal revenues
– Personal income tax
– Company income tax
– Indirect and other taxes

GST

excise tax

Copyright  2004 McGraw-Hill Australia Pty Ltd

PPTs t/a Macroeconomics 7/e by Jackson and McIver 9-3
Slides prepared by Muni Perumal, University of Canberra, Australia
 Discretionary Fiscal Policy
• The deliberate manipulation of taxes and
spending by government for the purpose
of altering real GDP and employment,
controlling inflation and stimulating
economic growth
• Not all fiscal policy is deliberate, a range
of automatic stabilisers are discussed later
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver 9-4
Slides prepared by Muni Perumal, University of Canberra, Australia
Expansionary Fiscal Policy
• Increased government spending or
lower taxes or increased transfer
payments (social security payments)
to reduce the effects of recession, i.e.
boost GDP and reduce unemployment

Copyright  2004 McGraw-Hill Australia Pty Ltd

PPTs t/a Macroeconomics 7/e by Jackson and McIver 9-5
Slides prepared by Muni Perumal, University of Canberra, Australia
 Expansionary Fiscal Policy
AS1
ASLS
Price level AD1

P2

P1

AD2
Q2
Q1 Qp
Real gross domestic product
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver 9-6
Slides prepared by Muni Perumal, University of Canberra, Australia
Contractionary Fiscal
Policy
• Decreased government spending or
higher taxes or a reduction in transfer
payments in order to reduce inflation
during a boom

Copyright  2004 McGraw-Hill Australia Pty Ltd

PPTs t/a Macroeconomics 7/e by Jackson and McIver 9-7
Slides prepared by Muni Perumal, University of Canberra, Australia
 Contractionary Fiscal Policy
ASLS AS1
Price level AD2

P2

P1

AD1

Q1 Qp
Real gross domestic product
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver 9-8
Slides prepared by Muni Perumal, University of Canberra, Australia
 Non-Discretionary Fiscal
Policy
• Built-in or automatic stabilisers that operate without
requiring explicit action by policy-makers, they are the
result of a progressive income taxes and a social
security system
• During recessions: Tend to increase government
deficits (or reduce surplus) through lower taxes and
higher welfare payments
• During inflationary periods: Tend to increase
government surpluses (or reduce deficits) through
higher taxes and lower welfare payments
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver 9-9
Slides prepared by Muni Perumal, University of Canberra, Australia
 Automatic or Built-in
Stabilisers
• Tax receipts: Increase as real GDP increases,
so the economy slows
• Transfers: Decrease as real GDP increases, but
increase when the economy slows so GDP and
AD increase.
• Do not fully correct the economy, only reduces
the severity of fluctuations
• Useful when economy is operating around full
employment
• Can cause problems: Fiscal Drag
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver 9-10
Slides prepared by Muni Perumal, University of Canberra, Australia
Automatic or Built-in Stabilisers
Flatten out the fluctuations in the business
cycle, but do not eliminate them completely
Level of business activity

Time
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver 5-11
Slides prepared by Muni Perumal, University of Canberra, Australia
 Problems with Fiscal
Policy in Practice
• Problems of timing
– Recognition lags
– Administrative lags
– Operational lags
• Political problems
– Other economic goals, economic growth
complements and conflicts with other policies
– Expansionary bias, often not used stimulate rather
than slow the economy
– The political cycle may accentuate the business cycle.
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver 9-12
Slides prepared by Muni Perumal, University of Canberra, Australia
 Fiscal Policy and
Aggregate Supply
• Fiscal policy, especially tax changes, affects not only
aggregate demand but can affect aggregate supply
• Tax changes in the form of incentives to businesses
and individuals as well as government spending in
infrastructure can lead to a rightward shift in the AS
in addition to increasing AD, providing a further
stimulus to the economy in terms of lower prices
and higher GDP

Copyright  2004 McGraw-Hill Australia Pty Ltd

PPTs t/a Macroeconomics 7/e by Jackson and McIver 9-13
Slides prepared by Muni Perumal, University of Canberra, Australia
 Supply-Side Effect of Fiscal Policy
AS1 AS2
ASLS
Price level AD1

P2
P3 = P1

AD2
Q1 Q2 Q3 Qp
Real gross domestic product
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 7/e by Jackson and McIver 9-14
Slides prepared by Muni Perumal, University of Canberra, Australia