ECO2013 week of 4/11-4/15
ECO2013 week of 4/11-4/15 ECO 2013
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This 7 page Class Notes was uploaded by Jessica Ralph on Sunday April 17, 2016. The Class Notes belongs to ECO 2013 at Florida State University taught by Joab Corey in Spring 2016. Since its upload, it has received 40 views. For similar materials see Macroeconomics in Economcs at Florida State University.
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Date Created: 04/17/16
4/11/16 Timing problems of fiscal policy (continued from last class) Automatic stabilizers: built in features that automatically promote a budget deficit during a recession and a budget surplus during an expansion (even without a change in policy) o 1. Unemployment compensation Recession: unemployment increases G increases, T decrease EXACTLY WHAT KEYNES POLICY DESCRIBES Budget deficit Expansion: unemployment decrease G decreases, T increases Budget surplus No change was legislated, but there are already things in place that naturally steer the economy out of the business cycle o 2. Corporate profit tax Corporations get taxed on income Recession: T decreases Expansion: T increases o 3. Progressive income tax When income is higher, your taxes are higher Recession: T decreases Expansion: T increases o ALL HAPPENS AUTOMOATICALLY AS PEOPLE ARE EITHER BECOMING EMPLOYED OR UNEMPLOYED- Review 1. What are the main differences between classical and Keynesian economics? 2. Calculate the marginal propensity to consume 3. Be able to calculate the multiplier effect and understand its implications 4. Know the Keynesian view of fiscal policy and what it does to the budget deficit 5. Know the timing problems associated with fiscal policy 6. Know the stabilizers and how they work Chapter 12: fiscal policy: incentives, and secondary effects Fiscal policy and crowding out Crowding-out: a reduction in private spending due to higher interest rates generated by budget deficits financed through government borrowing Process: o 1. Government conducts expansionary fiscal policy to bring economy out of a recession Recession expansionary fiscal policy (G increases, T decreases) o 2. This increases the budget deficit (which must be financed through borrowing) Increased deficit govt. borrowing increases o 3. Government borrowing increases the demand for loanable funds and thus interest rate Demand for loanable funds increases r increase o 4. Increase in interest rate causes consumption and investment to decrease. It also causes capital inflow to increase r increases consumption decrease, investment decreases r increases capital inflow increase $ appreciation US can buy more foreign goods so net export increase o 5. This causes the dollar to appreciate, which causes the net exports to decline (fiscal policy fails to bring economy out of a recession) o Crowding out process lists and graphs New classical view of fiscal policy What should we do in a recession o Keynesians: use expansionary fiscal policy o Classical: crowding out o New classical: ricardian equivalence New classical economists do not believe budget deficits will stimulate additional consumption and aggregate demand o Why not? Because people will save for the expected future tax increase (permanent income hypothesis) When you get a raise, you don’t go spend it all at once- you save some 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 o Loanable funds graph- ricardian equivalence graph Paradox of thrift Paradox of thrift: when many people drastically increase their savings and reduce consumption, total savings may decrease Another problem with fiscal policy Politicians have a tendency to overuse expansionary policy even when its not called for especially around election time The great debate The US is currently undergoing an experiment which has already been run by Japan and Canada 4/14/16 ***the Keynesian debate will never be fully settled because we will never know what would have happened if we hadn’t used Keynesian economics in the recession of 2008—classical economists say Keynesian economics didn’t work because the response was slow, Keynesian economists say it did work and we don’t know how we would have responded to classical theories*** Keynesian economics is almost always a popular choice in recession because no one wants to watch their government do nothing while the population is suffering Keynesian AND classical Agreements between Keynesian and classical economists o 1. Proper timing is crucial and hard to achieve o 2. Automatic stabilizers help redirect the economy 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 o 2. High tax rates reduce capital formation o 3. High tax rates encourage people to purchase goods that are less desired, just because they are tax deductible 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 more people the incentive to work more o if the lower marginal rate is believed to be long-term than it will shift both the SRAS and LRAS o Supply-side economics is a long-run, growth oriented strategy, not a short-run stabilization o Supply side economics graph Trickle down economics does not always work in the way intended o If the “trickle down” does not filter to the poorer individuals in the US and instead goes abroad, it is going to increase the wage gap 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 4. Know the 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 economics growth 7. Know the idea behind supply side economics Chapter 13: Monetary Policy- Money and the Banking System 3 functions of money Medium of exchange: used to buy goods and services o Imagine a world with no currency and only barter of exchange. You grow apples and want oranges. To obtain oranges, you must find someone who grows oranges and wants apples – “double coincidence of wants” o It is more efficient to use money than to barter goods o Fiat money: money that has no intrinsic value No longer entirely backed by gold due to collapse of Bretton Woods system A store of value: an asset that will allow people to transfer purchasing power from one period to the next o Liquid asset: asset that can be easily and quickly converted to purchasing power Unit of account: unit of measurement used by most people to post prices and keep track of revenues and costs