Macroeconomics Policies:Fiscal, Monetary and Supply Side Policies

Pg 17.1Chapt 17: PUBLIC FINANCE

Case study: Greece Financial Crisis-A pure lack of fiscal prudence

https://www.youtube.com/watch?time_continue=670&v=j4_tyEl84IQ

3.08‐ 6.42

Greece in 2015

• Two broad categories of Fiscal Policy• Automatic stabilisers and discretionary fiscal policy.

POLICYGovernment spending and/ or taxation to influence the level  of economic activity 

through AD

Pg 17.11

Aim and effect of Automatic Fiscal Stabilizers:Smooth out Business / Trade cycle

Automatic Fiscal Stabilizers

17.4.1 AUTOMATIC FISCAL STABILISERS 

• Built in features of the economy

• Operate without deliberategovernment intervention to smoothout fluctuations.

Pg 17.11

Automatic Fiscal Stabilizers

How do they work?

• Stimulates AD during recessions byincreasing C & I.

• Dampens AD during expansions byreducing C & I.

• Examples: Progressive income taxand transfer payments & subsidies(unemployment benefits).

Pg 17.11

Automatic Fiscal Stabilizers

Pg 17.5

https://www.iras.gov.sg/irashome/Individuals/Locals/Working‐Out‐Your‐Taxes/Income‐Tax‐Rates‐Foreigners/Sample‐Income‐Tax‐Calculations/

Example of an Automatic Fiscal StabilizerProgressive tax system : the tax takes a higher proportion of one’s income as income increases

Y falls, G, C and I falls, AD fallsPrevents Demand-Pull Inflation

Pg 17.11How do they work?

Automatic Fiscal Stabilizers

Lessens Cyclical Unemployment during recessionThink-Pair-Share: Explain how built in features operateautomatically to smooth out fluctuations by automaticallystimulating AD during recessions (2 mins)

Pg 17.1117.4.1 AUTOMATIC FISCAL STABILISERS 

Lessens Cyclical Unemployment during recession• Fall in incomes trigger a fall in tax receipts.• Transfer payments rises.

Overall effect: Maintain disposable incomes, hence partly counteringthe downward multiplier effect.

Pg 17.1117.4.1 AUTOMATIC FISCAL STABILISERS 

Limitations of automatic stablisers17.4.1.2 Limitations – Fiscal Drag• Tendency of automatic fiscal stabilisers to

reduce the recovery of an economy fromrecession

• As income , earners enter higher incomebrackets and pay more taxes which meansmore leakage.

• At the same time, less transfer payments,e.g. unemployment benefits will be paid out.

Overall effect: Dampening effect oneconomy’s recovery

Pg 17.13

A Level 2011 CSQ 2b(i) & (ii)(i) Describe the trend in the UK’s public sector debt (G-T) shown in Figure

2. [1](ii) With reference to the data, explain how recession affects public sector

debt. [3] Automatic Fiscal Stabilizers

Go menti.com55 33 30

(b) (ii) With reference to the data, explain how recession affects public sector debt (Govt. expenditure.>Tax revenue). [3]

Recession leads to a rising public sector debt because1. during recession there is a rise in unemployment which leads

to increasing welfare payments (Increased G spending)2. In addition there will be declining tax revenues as people pay

less income tax and also spend less, causing revenue fromincome tax and consumption/sales tax to fall (Reduced Trevenue)

Automatic Fiscal Stabilizers

17.4.2 DISCRETIONARY FISCAL POLICY & MACRO PROBLEMS

• Government can deliberately change its expenditure and/or taxesto influence AD.

• It is a DEMANDMANAGEMENT tool.

Pg 17.12

Great Depression USA (1929‐1939)

John Maynard Keynes

AD =  C +  I +   G +  (X – M) 

AD =  C +  I +   G +  (X – M) 

AD =  C +  I +   G +  (X – M) 

Government can also change taxes change disposable income to affect AD

Japan’s prime minister Shinzo Abe: New multi‐trillion yen programme of higher spending on welfare and infrastructure in the latest attempt to steer the country’s struggling economy away from deflation. 

DISCRETIONARY FISCAL POLICY: Budgetary Policy

Balanced budget (T=G)

Deficit budget (T<G)“Expansionary budget”

Surplus budget (T>G)“Contractionary budget”

Pg 17.14

Govt. BudgetRevenue ‐ Expenditure

Fiscal policy & demand deficiency

• Fiscal policy: Use of governmentspending and/or taxation* (direct)to influence AD.

• Expansionary fiscal policy:Resuscitate the economy

- How does expansionary fiscalpolicy affect AD? How does themultiplier process work? (Year 1Notes) What is the impact on ADand hence real NI?

- Diagram!

Pg 17.15

& Taxes

Limitations of Fiscal Policy to combat Demand Deficiency 1: Small Multiplier: Small k if there is huge leakage from circular flow

of income.

Pg 17.16

• Example: Singapore import almost everything.• Most of additional income earned are spent on

imports.• High MPM, hence contributing to small

multiplier size.• Compulsory/involuntary savings: significant

proportion of Singaporeans’ money is "lockedup" in CPF.

• Voluntary savings: Asian thrift• Most of additional income earned will be saved• High MPS, hence contributing to small

multiplier size.

2.Proportion of G in AD• Example: Singapore’s export revenue

is more than 20 times governmentspending.

• A fall in export revenue of 5% wouldrequire an increase in governmentspending by 100%

• → Fiscal policy is less effective forSingapore (small & open economy)

Limitations of Fiscal Policy to combat Demand Deficiency Pg 17.16

AD =  C +  I +   G +  (X – M) 

External conditions beyondour control

• Fiscal policy is ineffective ifother countries are also facingrecession.

• Dd for exports .• Rise in G will be too

insignificant to boost theoutput of our local industries

Limitations of Fiscal Policy to combat Demand Deficiency Pg 17.16

Limitations of Fiscal Policy to combat Demand Deficiency Pg 17.16

3. Limitations of taxcuts

• Consumers mayperceive tax cuts astemporary measures,they may not increaseconsumption.

• Investors may not beoptimistic about theeconomy despite taxcuts, private investmentmay not increase.

Limitations of Fiscal Policy to combat Demand Deficiency Pg 17.17

4. Time Lags• Time lag between problemidentification andimplementation of FiscalPolicy

• Can be destablising.

Limitations of Fiscal Policy to combat Demand Deficiency Pg 17.15

5. Relative Inflexibility• Approval for a change in the

budget is a long drawn process.• Governments may be reluctant

to increase spending during thefinancial year to address arecession.

• While it is faster to ∆T ratherthan ∆G, effect of ∆T on NI isweaker due to savings fromdisposable income.

Limitations of Fiscal Policy to combat Demand Deficiency Pg 17.15

Which of the above limitations are moreapplicable to SG and which are moreapplicable to US?

Singapore US• Small k size• Proportion of G to AD 

+ externally induced

• Relative inflexibility• Time lags

• Limitations of tax cuts

Pg 17.18

Expansionary or contractionary Fiscal Policy for Greece?

Greece Reduce G and Increase T (G>T)

WHY/AIM: 1. Reduce government debt or deficit

2. Restore confidence in the country and bring back investment and improve economic growth

Pg 17.10

HOW: Reduce G and Increase T to have G>T

Pg 17.10

6.45‐8 min

• WHY?: • Contrac onary effect on economies (↓material SOL) +

• No improvement in budget balance + • Riots + ↓SOL

(ineffective + unintended consequences)

Pg 17.10

Multi‐faceted and complex decision‐making process 

The Decision Making Process By the Government

1. To decide on macroeconomic aim:• Gather data to assess current state of economy• Gauge benefits and costs of choosing one to focus on one aim over another• Gather perspectives of various groups that make up the population

2. To decide on suitable policy:• Assess marginal benefits and marginal costs of selected policy via info gathering (data) and

perspectives of economic agents

3. Finally evaluate the outcomes of the policy:• SR vs LR• Intended vs unintended consequences

Repeat the DM process if there are changes in economicconditions

The Decision Making Process By the Government

1. Crowding-out effect• ↑G may not ↑AD due to a ↓C+I• Government may fund spending via

borrowing from private sector (e.g. Sellgovernment bonds)

• Private firms competing for the same poolof funds may have to offer higher interestrates - makes investing expensive

• If government borrows from the bank,less funds available for private firms toborrow, interest rate rises, ↓investment.

Unintended consequences of Fiscal PolicyPg 17.15

Crowding-out effect

•Crowding‐out effect occurs when governmentspending fails to increase overall aggregate demandbecause higher government spending causes a fall inprivate sector spending and investment.

•Note: The fall in C and I needs not be the sameamount as a rise in G.

http://www.usdebtclock.org/

Unintended consequences of Fiscal PolicyPg 17.17

2. Unfavourable Consequences of High National Debt

Unintended consequences of Fiscal PolicyPg 17.16

2. Unfavourable Consequences of High National DebtHow is government debt created?• Government debt created when

government expenditure exceeds

tax revenue collected (G>T).

Unintended consequences of Fiscal PolicyPg 17.16

2. Unfavourable Consequences of High National DebtWhen is debt a problem?• Growing debt is a concern as interest payments takes up a larger

proportion of NI..

Unintended consequences of Fiscal PolicyPg 17.16

• Government revenue is now used to pay debt and not spenton growing the economy. (Recall: OPPORTUNITY COSTS!)

• Funding debt via increasing tax increases disincentive towork, save and invest.

https://www.nationaldebtclocks.org/debtclock/singapore

• FP signals that Government is trying to resuscitate the economy

•‘crowding-in’ effect.

Why fiscal policy given all the limitations?Pg 17.18

‘Crowding-in’ effect.

•Y = k*AD which means even if AD or k is small for somecountries, there is still positive impact on the national income whenthere is a rise in autonomous spending such as governmentexpenditure.

• It helps to ‘jump-start’ the recovery of a weak economy.• It boosts the confidence of both investors and consumers.• When business and consumers feel optimistic about the economy, they

increase I and C which help the economy recover.

Why fiscal policy given all the limitations?Pg 17.18

3. Which of the above limitations are more applicable to Singapore and US? Justify your answer.

• None are application for Singapore.  • When Singapore Government spends, the aim is to improve the supply or the RESOURCE side of an economy and thereby contribute to a faster rate of growth of real national output.  

• It is rarely to stimulate the economy given that we are a small and open economy, which reduces the effectiveness of fiscal policy.

• Both are applicable to the USA (Crowding out and unfavourableconsequence of high national debt)

17.4.2.2 Fiscal policy & demand‐pull inflation

• How to deal with an overheating economy (inflation)?• Governments can adopt a contractionary fiscal policy

to reduce AD.

Pg 17.19

• Involve eithergovernmentexpenditure (G) ortaxes (T).

• in T-> indisposable income ->C and I

• Result: in AD, ingeneral price level.

Pg 17.19

How Fiscal policy to reduce demand‐pull inflation

1: Good economic outlookConsumers and firms reluctant to reduce spending and investment due to higherexpectations of income and after-tax profits

Pg 17.19

Limitations of Fiscal policy to reduce demand‐pull inflation (2 points)

2: Relative Inflexibility to ∆G• Government spending mainly

tied to long term contracts;social, political projects.

• Tough for government toreduce spending.

Pg 17.19

Limitations of Fiscal policy to reduce demand‐pull inflation

Trade-offs• ↑Direct taxes, ↓incentive

to work, investment, limit↑ in LRAS↓Government spending,↓essential consumergoods to lower incomehouseholds

Unintended Consequences of Fiscal policy to reduce demand‐pull inflation

Pg 17.19

• Contractionary fiscal policy- > Conflicting goals withgrowth and employment.

• Worst fear - Hard-landing: Directly expansion to recession• Best: Use Long-term policy Increase the economy’s

productive capacity for non-inflationary growth.

Pg 17.19

1980s

Contractionary monetary policy was implemented in 1982.  What was the trade‐off?

1980s

Trade off: Low inflation and Low unemployment

•What is the relationship between GDP and income inequality?

Economic Growth versus Equity

• opportunities for incomes of the able, talented and entrepreneurial individuals to surge ahead 

• compared to income of workers with low skills and education. 

S0

D1

S0

D

Globalization impact on Low skills and education workers

Wages S1

WL0WL1

No. of workers

D0

Globalization impact on High skills and education workers

Wages

WH0

WH1

No. of workers

Economic growth versus low unemployment• Supply‐side stimulated growth may lead to a rise in structural unemployment

• Supply‐side policies refer to policies: aimed at increasing the productivity of the economy via innovation such as introduction of new products and new technology into the production process to stimulate growth

• Introduction of new technology and new products might alter the kind of skills required by the labour market. 

• Existing workers in the labour force without the new skills might lose their jobs.

What will happen to these workers? What kind of Un‐ is this?

Economic growth versus low unemployment

• Supply‐side stimulated growth may lead to a rise in structural unemployment

. 

Economic growth versus low unemployment

What happens if government were to discouragetechnological progress and choose not to restructure theeconomy?

Short Run Long Run

Economic Growth versus Equity

• pursuing growth involves the use of policies that might conflict with equitable income distribution. 

• cutting corporate taxes and the top marginal tax rates for personal incomes 

• while at the same time raise indirect taxes e.g. GST on consumption

Regressive tax system 

• tax takes a smaller proportion of income as income increases.

Pg 17.5

income consumption Tax paid (GST 10%)

Tax/ Income 

1000 1 000 100 10%

5000 4 500 450 9%

10 000 8 000 800 8%

100 000 30 000 3000 3%

Economic Growth versus Equity

• Cutting corporate taxes and the top marginal tax rates for personal incomes 

• And increasing GST

Accentuates income inequality

Conclusion•What should governments priortise?

•What to trade‐off?

Will the lower income really have more pie?

http://www.straitstimes.com/opinion/why‐spore‐gives‐top‐priority‐to‐fighting‐income‐inequality

Will the lower income really have more pie?

Will the lower income really have more pie?

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