Fiscal Policy 

Fiscal Policy 

Humanities –

 

DQ1

For this week’s discussion, choose realism or impressionism as a basis for your posts and discuss how your choice is manifested in any area of the humanities (i.e., painting, sculpture, literature, music, etc.), and give an example from any discipline in the humanities to illustrate how realism or impressionism influenced the work of art. Please be sure to give an analysis of how the work of art was influenced by the movement.

 

 

ECON – Fiscal Policy 

 

DQ1
Fiscal policy refers to managing gov’t spending to speed up, or slow down, economic activity.  Fiscal stimulation can come in two forms, increased deficit spending (which is expansionary), or though tax reductions (which also increase deficits, but let us do the spending instead of the gov’t).  Both methods are stimulative, and can increase employment.

Tax cuts are obviously the more popular of the two methods.  People have no problem at all with lower taxes, although increased deficit spending does effectively the same thing.  The problem with tax cuts, as we’ll discuss below, is that people sometimes don’t use them for new purchases, but pay off bills incurred for purchases in prior periods, like credit card bills.  While this may be good for the individual, it doesn’t have the intended effect on the economy.

Experience has shown that if we put large sums in the hands of the people all at once, without some kind of assurance that this rebate or stimulus payment will be recurring, people tend to look at the money as a one-off event, and use it to pay down bills, credit cards, or simply save it instead of consuming. This doesn’t have the desired effect, as the last thing we need right now is more saving (look at CD interest rates for evidence of this). We need more consumption, so rebates and tax reductions may not be a good idea, or at least, not have the desired stimulative effect.

One thing that we’ve done differently this time around is to lower withholding taxes instead of just sending out a rebate check. The thinking here is that the increase in income will be smaller each week, and appear to be more permanent, and recurring. These two factors, combined, will cause more of the money to be used for consumption rather than savings. Do you thing this strategy is sound?

The alternative to tax cuts is just to have the government go ahead and spend the money directly themselves. That way, there’s no worry about saving; there is none. All of the money ends up being spent, and so becomes income to the next person in line. Being income (rather than a one-shot tax rebate), it’s more likely to be spent in the second round of spending, too.

During periods of high inflation and low unemployment, the gov’t can do the reverse, and raise taxes or spend less than they take in.  This is called contractionary fiscal policy.  Is there any place for contractionary fiscal policy (taxing more than spending) in order to slow the economy today? Or is this something we can wait to worry about until times get better?

 

ECON – Aggregate Demand and Aggregate Supply

DQ2
Now, look at the AD curve and notice what’s being graphed. Here we have the overall, general price level on the vertical axis (by now you’ve noticed that price is ALWAYS on this axis, (Price is uP, right), and the “real” GDP along the horizontal. In this case, price refers to the overall, “general” level of prices. Why does this curve slope downward?

Not for the same reasons as demand for a single good (the substitution effect or the income effect), in this case, the price relates to ALL goods, so substitution is not possible, nor is the income effect, because GDP IS income, right?. The answer lies in understanding a couple of other things:

A: The real balances effect. When prices are high, people feel that their wealth has decreased, and do they don’t consume as much.

B: The interest rate effect. When prices are high, people have a larger demand for cash (for transactions) resulting in a higher price for cash (the interest rate). Higher interest rates cause consumption to be lower, as consumers tend to finance large purchases.

C. The foreign purchases effect. When prices in this county are high, exports tend to go down because they’re expensive to foreigners, and vice versa.

So there are three, new, completely different reasons why the aggregate demand curve declines, none of which is the same as why the demand curve for individual products declines!

Okay, so the overall price level is the factor that directly causes real GDP to move. Are there determinants of this kind of demand? Sure, changes in C, I, G, and X all can move the AD curve itself, rather than cause movement along it. Why would these things change? That’s what you’ll learn this week.

Why does the AS curve slope up? Well, for the most part, because the more production happens, the more expensive it becomes to produce more (we start to run out of idle resources and people). Prices reflect cost, and so producers charge more for increasing amounts of product. Eventually, the AS curve actually becomes vertical! We run out of productive capacity and only price can change in response to increased demand!

When you spend money, you know by now that it becomes income to someone else, and they spend most of it, too (they save the rest). The third person in the chain also spends most of what the second persons spend, and they too save the rest. This would go on forever except for the leakage that the savings rate inflicts on the process. So it’s not to hard to figure out, at least intuitively, that savings must have something to do with slowing down the “multiplier” process. It does, and in fact, the multiplier is 1 / MPS, MPS being the marginal propensity to save, the amount of the last dollar earned that we save. The higher MPS, the lower is the multiplier.

Do the AS curve and the AD curve lead to some kind of equilibrium? Sure, but not necessarily one that includes full employment. They can permanently get “stuck” at a level of prices and output without everyone having a job!

If that were to happen (and it has in the past), what component of GDP could change the quickest to increase aggregate demand? And what actions by the Federal Reserve Bank could cause this change to occur the most quickly?