Eco 2013, week 10 notes
Eco 2013, week 10 notes Eco2013
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This 4 page Class Notes was uploaded by Lauren Carstens on Friday April 15, 2016. The Class Notes belongs to Eco2013 at Florida State University taught by Joan Corey in Spring 2016. Since its upload, it has received 16 views. For similar materials see Principles of Macroeconomics in Economcs at Florida State University.
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Date Created: 04/15/16
Macroeconomics Chapter 12: Fiscal Policy: Incentives and Secondary Effects Keynesian vs. Classical Keynesian Economist: expansionary fiscal policy during a recession will stimulate AD and pull us out of a recession Classical: Possibly, but maybe not because of crowding out o Crowding out: A reduction in private spending due to higher interest rates generated by budget deficits financed through government borrowing There’s no such thing as a free lunch The crowding out process 1. When we are in a recession the government conducts expansionary fiscal policy to bring the economy out o Government spending increases while taxes decrease 2. This increases the budget deficit (which must be financed through borrowing) government borrowing increases 3. Government borrowing more Demand for loanable funds increases interest rates (r) increase 4. Increase in interest rate consumption and investment decrease Capital inflow increases 5. The dollar appreciates Net exports decline (fiscal policy fails to bring the economy out of a recession According to Classical economists, when real interest rates are going up Consumption and investment goes down Capital inflow increases Dollar appreciates Net exports decrease New Classical View of Fiscal Policy Keynesians: use expansionary fiscal policy in a recession Classical: Crowding out New classical: Ricardian Equivalence o Don’t believe that budget deficits will stimulate additional consumption and AD o Because people will save for the expected future tax increase (permanent income hypothesis) The government jacks up their deficits People realize that their taxes will increase in future so they save o Ricardian Equivalence: belief that a tax reduction financed with government debt will exert no effect on aggregate demand because people will know that higher future taxes are coming Keynesian’s Paradox of Thrift When many people drastically increase their savings and reduce consumption, total savings may decrease o If someone puts all their money in the bank, the company will need to produce less and will lay off employees they now have less money to save and spend Problems with Fiscal Policy Politicians have a tendency to overuse expansionary policy (even when it is not called for) o Especially around election time (giving us stuff and charging less to get votes) o Everyone wants to decrease government spending, but not decrease the spending on them o DEBT The Great Debate The US is currently undergoing an experiment which has already been run by two other countries I don’t know why this is significant Keynesian AND Classical Most macroeconomics, both Keynesian and Classical believe o 1. Proper timing is crucial and hard to achieve Using the counter-cyclical method to steer the economy o 2. Automatic stabilizers do help redirect the economy Makes the timing even more difficult o 3. Fiscal policy is less potent than originally thought Taxes and Growth High taxes retard growth because o 1. High tax rates discourage work effort and productivity You will be receiving less of the money you’re working for o 2. High tax rates reduce capital formation People may stop buying more expensive material even if it is much more efficient just because the taxes increase Less production o 3. High tax rates encourage people to purchase goods that are less desired, just because they are tax deductible Businesses may spend extra money on things they don’t need (business trip to Hawaii) just to write off more costs (less profit) and get taxed less Fiscal Policy and Supply Side Economics Supply-side Economics: The belief that changes in the marginal tax rate will exert important effects on aggregate supply o A lower marginal tax rate will give people more incentive to work more o If the lower marginal rate is believed to be long-term, it will shift both SRAS and LRAS As SRAS and LRAS shift right, AD will also shift right because people will spend more with lower taxes o Supply side economics is a long-run, growth oriented strategy, not a short-run stabilization tool o Low taxes for everyone will help the economy grow Review 1. Know what crowding out is and how it occurs 2. Know the new classical view of fiscal policy 3. Understand what is meant by the paradox of thrift a. Increasing savings may decrease savings in the long run 4. Know they perverse political incentives of discretionary fiscal policy 5. Know the Classical vs. Keynesian debate 6. Understand what goes into the relationship between low taxes and economic growth 7. Know the idea behind supply side economics Macroeconomics Chapter 13: Money and the Banking System To stimulate the economy o Fiscal policy Done by the government Expansionary (government spending increase, taxes decrease Restrictive (government spending decreases, taxes increase) o Monetary policy Done by the Federal Reserve Expansionary (money supply increases) Restrictive (money supply decreases) The Three Functions of Money 1. Money is used as a medium of exchange o Used to buy goods and services o Double coincidence of life: finding someone who wants what you have and has what you want o It is more efficient to use money than to barter good o Fiat money: Money that has no intrinsic value No longer backed by gold 2. A store of value o An asset that will allow people to transfer purchasing power from one period to the next o Liquid assets: Asset that can be easily and quickly converted to purchasing power Not chairs 3. Money serves as a unit of account (measurement) o A unit of measurement used by most people to post prices and keep track of revenues and costs
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