Cases of discretionary fiscal policy: expansionary and conctractionary policy.
There are 2 cases:
An expansionary fiscal policy
The economy is experiencing recession and cyclical unemployment: reducing investment spending and AD.
3 main fiscal policy options during recession:
1) increase government spending- Increasing G pushes the economy out of recession. Real GDP rises;
2) Reduce taxes- AE=C+I;
C is determined by Dl.
To increase initial consumption by specific amount, government must reduce taxes by more, than that amount.
Tax reduction :
C1=Co+MPC
C2=Co+MPC
BUT Fiscal policy during recession or depression should create a government budget deficit – government spending in excess of tax revenues.
A contractionary fiscal policy
Government looks to fiscal policy to control inflation.
3 options:
1. Decrease G;
Demand-pull inflation is experienced as a shifting AE(AD) up. Fiscal policy is desingned to stop such shifts.
2. Raise taxes;
C1=C0+MPC(DI+T)
C2=C0+MPC(DI-T)
3. Use some combination of the two.
BUT!Contractionary f.p should move toward a government budget surplus- tax revenues in excess of government spending.
Financing of deficit
· Borrowing.
· Money creation.
Disposing of surpluses.
· Debt reduction
Impounding
33. Nondiscretionary Fiscal Policy. Built-in stabilizers.This is the policy of built-in stabilizers.Government tax revenues change automatically over the course of the business cycle.
"Nondiscretionary"-taxes
Personal income taxes have progressive rates and thus yield more than proportionate increases in tax revenues as GDP expands.
"Nondiscretionary"-transfer payments
Unemployment compensation payments,welfare payments,subsides all decrease during economic expansion and increase during a contraction.
A Built-in stabilizer
Is anything which increases the government budget deficit (or reduces its budget surplus) during a recssion and increases its budget surplus(or reduces its budget deficit) during inflation without requiring explicit action by policfymakers.
Economic importance of Built-in stabilizers
1.Taxes reduce spending and AD
2.It is desirable from the standpoint of stability to reduce spnding when the economy is moving doward inflation
Problems and complications of fiscal policy. ?
Money: functions and types.
Functions: -to serve as a medium of exchange
- to serve as a measure of value
Types: 1) commodity money (gold coins)
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2) fiat money (bills)
3) bank money (book credit)
Supply for money.
Money definition(aggregates):
·M0
·M1
·M2
·M3
M0- all currency (notes and coins) in circulation
M1- it includes:
·all currency (notes and coins) in circulation,
·all checkable deposits( bank money)
·all traveler's checks
M2- it includes:
·all of M1
·plus savings and time deposits
M3- it includes:
·all of M2
plus large denomination, long-term time deposits
The role of banking sector - creation process.
There are 2 crucial functions:
·they receive funds from depositors and, in return, provide these depositors with a checkable source of funds or with interest payments.
·they use the funds that they receive from depositors to make loans to borrowers; that is, they serve as intermediaries in the borrowing and lending process.
When banks receive deposits, they do not keep all of these deposits on hand because they know that depositors will not demand all of these deposits at once.
Instead, banks keep only a fraction of the deposits that they receive.
· The deposits that banks keep on hand are know as the banks' reserves.
· The reserve requirement is the fraction of deposits set aside for withdrawal purposes ( is determined by the nation's banking authority).
· Deposits that banks are not required can be lent to borrowers, in the form of loans.
·Banks profits is the difference between higher rates of interest
Money – creation system. Money multiplier.
Money creation - is the process by which the money supply of a country or a monetary region is increased
Money Multiplier.
The amount by which bank deposits expand in response to an increase in excess reserves is found through these of the money multiplier.
·If some loan funds are held as currency, then there is a leakage of money out of the banking system
·money multiplier will still be greater than 1, but less than inverse of the reserve requirement.
Mm(Money Multiplier)=1/r r (reserve requirement)*100%
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