CHAPTER16Fiscal PolicyChapterOutlineandLearningObjectives16.1WhatlsFiscalPolicy?JOB CREATIONALECOT16.2TheEffectsofFiscal PolicyonRealGDPandthePriceLevel16.3 Fiscal Policy intheDynamicAggregateDemandandAggregate Supply Model16.4TheGovernmentPurchasesandTaxMultipliers16.5 TheLimits ofUsingFiscal PolicytoStabilize the Economy16.6Deficits,Surpluses,andFederalGovernmentDebt16.7TheEffectsof Fiscal Policy intheLongRunAppendix:ACloserLookattheMultiplier
1 Chapter Outline and Learning Objectives 16.1 What Is Fiscal Policy? 16.2 The Effects of Fiscal Policy on Real GDP and the Price Level 16.3 Fiscal Policy in the Dynamic Aggregate Demand and Aggregate Supply Model 16.4 The Government Purchases and Tax Multipliers 16.5 The Limits of Using Fiscal Policy to Stabilize the Economy 16.6 Deficits, Surpluses, and Federal Government Debt 16.7 The Effects of Fiscal Policy in the Long Run Appendix: A Closer Look at the Multiplier CHAPTER 16 CHAPTER Fiscal Policy
DoesGovernmentSpendingCreateJobs?Government spending is a component of real GDP:Y=C+I+G+NXThis makes it appear as though increases in government spendingincrease output-and hence other relevant economic variables likeemployment.However some economistsarguethatgovernment spending simplyshifts employment from one group to another-it does not increasetotalemployment.:This debate was particularly important after the 2007-2009recession: can the government use discretionaryfiscal policytoincrease employment?@2015Pearson Education,Inc
© 2015 Pearson Education, Inc. 2 Does Government Spending Create Jobs? Government spending is a component of real GDP: Y = C + I + G + NX This makes it appear as though increases in government spending increase output—and hence other relevant economic variables like employment. However some economists argue that government spending simply shifts employment from one group to another—it does not increase total employment. • This debate was particularly important after the 2007-2009 recession: can the government use discretionary fiscal policy to increase employment?
WhatisFiscalPolicy16.1LEARNINGOBJECTIVEDefinefiscalpolicy@2015PearsonEducation,Inc3
LEARNING OBJECTIVE © 2015 Pearson Education, Inc. 3 What is Fiscal Policy 16.1 Define fiscal policy
Fiscal PolicyDefinedFiscal policy refers to changes infederaltaxes andpurchases thatare intended to achieve macroeconomic policy objectives.(State taxes and spending are not generally aimed at affectingnational-levelobjectives.)Some forms of government spending and taxes automaticallyincrease or decrease along withthe business cycle;theseareautomaticstabilizers.Example:Unemployment insurancepayments arelargerduringarecession.Discretionary fiscal policy, on the other hand, refers to intentionalactionsthegovernmenttakestochange spending ortaxes@2015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 4 Fiscal Policy Defined Fiscal policy refers to changes in federal taxes and purchases that are intended to achieve macroeconomic policy objectives. (State taxes and spending are not generally aimed at affecting national-level objectives.) Some forms of government spending and taxes automatically increase or decrease along with the business cycle; these are automatic stabilizers. Example: Unemployment insurance payments are larger during a recession. Discretionary fiscal policy, on the other hand, refers to intentional actions the government takes to change spending or taxes
How Much Government Spending Is Federal?Federal 100%expendituresasapercentageoftotal90governmentexpenditures807060World War Il5040GreatDepression30194919291939195919691979198919992009BeforetheGreatDepressionoftheFigure 16.1Thefederalgovernment's1930s,mostgovernmentspendingshareoftotalexpenditures,1929-2012was at the state or local level;nowthe federal government's shareistwo-thirdstothree-guarters2015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 5 How Much Government Spending Is Federal? Before the Great Depression of the 1930s, most government spending was at the state or local level; now the federal government’s share is two-thirds to three-quarters. The federal government’s share of total expenditures, 1929-2012 Figure 16.1
Federal Expenditures as a Percentageof GDPSpendingas30%apercentageofGDPRecessionofTotalexpenditures252007-2009PassageofMedicare20EndofWarinVietnam15Endof ColdWar10Purchasesof5goods and serviceso1950195519601965197019751980198519901995200020052010Figure 16.2FederalpurchasesandAs a percentage of GDP,federalfederalexpendituresasexpenditures are nowhigherthanever-a percentage ofGDP,1950-2012almost 25% of GDP.However a smallerproportion is now spentongovernment purchases of goods andservices (mostly military spending)6@2015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 6 Federal Expenditures as a Percentage of GDP As a percentage of GDP, federal expenditures are now higher than ever— almost 25% of GDP. However a smaller proportion is now spent on government purchases of goods and services (mostly military spending). Federal purchases and federal expenditures as a percentage of GDP, 1950-2012 Figure 16.2
What Does the Federal Government Spend Money On?Federal purchases consist ofdefense spending and "everythingelse",likesalariesofFBlagents,operating national parks, andOtherexpenditures8.2%funding scientific research.InterestpaymentsAroundhalf offederal11.2%expenditures are spent ontransfer payments,like SocialTransferpaymentsGrantstoSecurity,Medicare,and46.4%state and localgovernmentsunemployment insurance.12.6%The rest is spent on grants tostate and local governments to Defense spending21.7%support their activities, like crimeprevention and education; and onFigure 16.3Federalgovernmentpaying interest on the federalexpenditures,2012debt.2015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 7 What Does the Federal Government Spend Money On? Federal purchases consist of defense spending and “everything else”, like salaries of FBI agents, operating national parks, and funding scientific research. Around half of federal expenditures are spent on transfer payments, like Social Security, Medicare, and unemployment insurance. The rest is spent on grants to state and local governments to support their activities, like crime prevention and education; and on paying interest on the federal debt. Federal government expenditures, 2012 Figure 16.3
Where Does the Federal Government Get Money From?The majority of federalrevenues comefromtaxes onindividual employment:individualincometaxesandOthertaxes andothersourcesofrevenue,“payroll taxes”earmarked to8.5%fund Social Security andMedicare.Corporate incometaxes,13.9%Taxes on corporate profitsIndividual incometaxes,constitute about one-seventh42.7%of federal receiptsThe remainder of federalSocial insurancetaxes,revenue comes from excise35.0%taxes (on cigarettes,gasolineetc.), tariffs on imports, andFigure 16.4Federal governmentrevenue,2012otherfeesfromfirmsandindividuals.2015PearsonEducation,Inc.8
© 2015 Pearson Education, Inc. 8 Where Does the Federal Government Get Money From? The majority of federal revenues come from taxes on individual employment: individual income taxes and “payroll taxes” earmarked to fund Social Security and Medicare. Taxes on corporate profits constitute about one-seventh of federal receipts. The remainder of federal revenue comes from excise taxes (on cigarettes, gasoline, etc.), tariffs on imports, and other fees from firms and individuals. Federal government revenue, 2012 Figure 16.4
MakingSocial Security and Medicare:Fiscal Time Bombs?theConnectionSocial Security and Medicare have helped to reduce poverty amongthe elderly, while Medicaid helps improve the health of poor people.. But the aging population and rising health care costs arecombining to put those programs in jeopardy.Through 2090, the budget shortfall for these programs is estimatedto beenormous:almost $6o trillion.SocialSecurity，25%Medicare,andMedicaidspendingasa20MedicareandMedicaidpercentageofGDP1510Social Security51962197219821992200220122022203220422052206220722082@2015Pearson Education,Inc.O
© 2015 Pearson Education, Inc. 9 Making the Connection Social Security and Medicare: Fiscal Time Bombs? Social Security and Medicare have helped to reduce poverty among the elderly, while Medicaid helps improve the health of poor people. • But the aging population and rising health care costs are combining to put those programs in jeopardy. • Through 2090, the budget shortfall for these programs is estimated to be enormous: almost $60 trillion
MakingSocial Security and Medicare: Is There a Fix?theConnectionHow can these programs continuetoexist?It is likelythat a combination of these measures will eventually needto be adopted:IncreasingtaxesDecreasing benefits (including slower benefit growth, perhapsdifferently for different income groups)Decreasing eligibility (SSl age already increasing from 65 to 67)But perhaps the most important element will be finding a way toreducemedicalcosts10@2015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 10 Making the Connection Social Security and Medicare: Is There a Fix? How can these programs continue to exist? It is likely that a combination of these measures will eventually need to be adopted: • Increasing taxes • Decreasing benefits (including slower benefit growth, perhaps differently for different income groups) • Decreasing eligibility (SSI age already increasing from 65 to 67) But perhaps the most important element will be finding a way to reduce medical costs