lectures in macroeconomics- charles w. upton fiscal policy-part 2

Lectures in Macroeconomics- Charles W. Upton

Fiscal Policy-Part 2

Y

M

Po

ro

Fiscal Policy-Part 2

Changing the Experiment Again

Y

M

Po

ro

Fiscal Policy-Part 2

Changing the Experiment Again

Y

M

Po

ro

Let’s change the experiment again. This time, the government

gives everyone a $300 tax cut.

Fiscal Policy-Part 2

Changing the Experiment Again

Y

M

Po

ro

Let’s change the experiment again. This time, the government

gives everyone a $300 tax cut.Yes you have

seen this one before.

Fiscal Policy-Part 2

Changing the Experiment Again

Y

M

Po

ro

Let’s change the experiment again. This time, the government

gives everyone a $300 tax cut.Yes you have

seen this one before.

This tax cut is based on last year’s taxes,

so no incentives/disincentives to work.

Fiscal Policy-Part 2

Changing the Experiment Again

Y

M

Po

ro

Let’s change the experiment again. This time, the government

gives everyone a $300 tax cut.Yes you have

seen this one before.

This tax cut is based on last year’s taxes,

so no incentives/disincentives to work.

But there are possible impacts

on wealth.

Fiscal Policy-Part 2

Tax Cut, Bequest Motive

Y

M

Po

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If people have a bequest motive, no

change

Fiscal Policy-Part 2

Tax Cut, Bequest Motive

Y

M

Po

ro

If people have a bequest motive, no

changeNo change in wealth, just an

issue on when you write a check to the government

Fiscal Policy-Part 2

Tax Cut, no Bequest Motive

Y

M

Po

ro

If people do not have a bequest motive, wealth

is up

Fiscal Policy-Part 2

Tax Cut, no Bequest Motive

Y

M

Po

ro

Fiscal Policy-Part 2

Tax Cut, no Bequest Motive

Y

M

Po

ro

Prices up, interest rates unsure (but probably up)

Fiscal Policy-Part 2

Tax Cut, no Bequest Motive

Y

M

Po

ro

Prices up, interest rates unsure (but probably up)But the change is

probably pretty small

Fiscal Policy-Part 2

A Summing Up

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M

Po

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Fiscal Policy-Part 2

A Summing Up

Y

M

Po

ro

A one time increase in government

spending pushes prices up, and

probably interest rates as well

Fiscal Policy-Part 2

A Summing Up

Y

M

Po

ro

A one time increase in government

spending pushes prices up, and

probably interest rates as well

If people have a bequest motive, it

makes no difference whether the increase

is financed by taxation or borrowing (ignoring the disincentive effects

of taxes).

Fiscal Policy-Part 2

A Summing Up

Y

M

Po

ro

A one time increase in government

spending pushes prices up, and

probably interest rates as well

If people have a bequest motive, it

makes no difference whether the increase

is financed by taxation or borrowing (ignoring the disincentive effects

of taxes).

With no bequest motive, it may make a small

difference.

Fiscal Policy-Part 2

A Summing Up

Y

M

Po

ro

A tax cut makes no difference if

there is a bequest motive.

Fiscal Policy-Part 2

A Summing Up

Y

M

Po

ro

A tax cut makes no difference if

there is a bequest motive.

With no bequest motive, it may make a small

difference.

Fiscal Policy-Part 2

Long Run Effects

• Let’s go back to our tax-financed spending increase.

• This is a temporary change.

• Its effects will eventually dissipate.

Fiscal Policy-Part 2

Long Run Effects

ro

Fiscal Policy-Part 2

Long Run Effects

ro

Fiscal Policy-Part 2

Long Run Effects

ro

No permanent impact

Fiscal Policy-Part 2

Prices

Po

No permanent impact

Fiscal Policy-Part 2

Prices

Po

No permanent impact

That means the change if initially

inflationary, will be deflationary as the impact wears off

Fiscal Policy-Part 2

Prices

Po

Fiscal Policy-Part 2

A Final Experiment

Y

M

Po

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Fiscal Policy-Part 2

A Final Experiment

Y

M

Po

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There is a permanent increase in government spending.

Fiscal Policy-Part 2

A Final Experiment

Y

M

Po

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There is a permanent increase in government spending.

We will assume a

foolish project.

Because it is a permanent increase it must be financed

by taxation.

Fiscal Policy-Part 2

A Final Experiment

Y

M

Po

ro

There is a permanent increase in government spending.

We will assume a

foolish project.

Because it is a permanent increase it must be financed

by taxation.

Any disincentive effects are small: people move

along their LR labor supply curve.

Fiscal Policy-Part 2

A Final Experiment

Y

M

Po

ro

Impact of Government

Spending

Fiscal Policy-Part 2

A Final Experiment

Y

M

Po

ro

Impact of Government

SpendingImpact of reduced wealth

Fiscal Policy-Part 2

A Final Experiment

Y

M

Po

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Impact of Government

SpendingImpact of reduced wealth

The proof is complicated,

but the two will exactly offset each other.

Fiscal Policy-Part 2

Ergo

Y

M

Po

ro

No change in Y curve!

Fiscal Policy-Part 2

The M Curve

Y

M

Po

ro

Fiscal Policy-Part 2

The M Curve

Y

M

Po

ro

Prices up, interest rates

down.

Fiscal Policy-Part 2

The M Curve

Y

M

Po

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Prices up, interest rates

down.

Over time, though,

interest rates unchanged,

prices up more.

Fiscal Policy-Part 2

End

©2004 Charles W. Upton. All rights reserved