Week 11 - fiscal policy

Question 1

What is an automatic stabiliser?

Answer 1

gov spending or taxes that automatically increase or decrease with the business cycle. E.g. welfare payments are countercyclical and increase with falling output, raising G and increasing AD.

Question 2

Discretionary definition

Answer 2

Gov takes action to change G or T to achieve its economic objective

Question 3

What is the gov purchase/tax multiplier

Answer 3

GPM = change in equilirium GDP/change in gov purchases or taxes

Question 4

What are policy time lags?

Answer 4

• implementation lag
• impact lag
• recognition lag

Question 5

What are political asymmetries?

Answer 5

Expansionary policy is typically more attractive politically and can be hard to unwind. Elected officials may opt for the best option politically rather than economically.

Question 6

What is resource crowding out?

Answer 6

situation where with full employment, an increase in G simply replaces private expenditure

Question 7

What is financial crowding out?

Answer 7

occurs when gov borrowing leads to higher interest rates, which discourages private investment.

Question 8

Formula for gov budget constraint

Answer 8

Gov spending + transfers + interest repayments = taxes + new debt + change in money supply

Question 9

Why is a budget not always balanced?

Answer 9

maintaining a balanced budget each year may involve policies that may destabilise the economy - long-run fiscal solvency needs to be considered though.

Debt to fund long-run infrastructure makes sense, the problem arises when repayments are too burdensome (implies opportunity cost)

Question 10

What happened in the GFC?

Answer 10

• world equity markets contracted
• world trade fell
• interest rates were cut significantly
• government went into deficit to stimulate the economy (opposite of Great Depression). This follows Keynesian thinking: in severe contractions, demand doesn’t respond normally so gov intervention is necessary

Question 11

What happened in the GFC in Australia?

Answer 11

• Australia acted quickly in getting money to people and institutions that would spend it
• nation building and jobs plan
• spending and taxing directed to highest MPC groups
  such as tax bonus payments and spending to schools
• spending happened quickly to prevent permanent sluggishness

Question 12

What is the intertemporal budget constraint?

Answer 12

measure of gov fiscal constraint over time

present value of spending + present value of debt and present value taxes.

Question 13

What is ricardian equivalence

Answer 13

Argues fiscal policy won’t work as any increase in G has to be financed by higher taxes in the future. Rational agents will figure this out and cut back consumption in response to higher gov spending or cut in taxes. In only makes sense in the long run and real world evidence is limited

Question 14

What is the problem with a single currency?

Answer 14

You can’t expand aggregate demand by raising net exports. This happened in the Eurozone.

Question 15

What is the level of debt limited to

Answer 15

Amount the gov can credibly be expected to pay, partly depends on GDP level. Can grow if GDP grows faster

Question 16

What happens when debt gets too high

Answer 16

lenders worry about the ability of the gov to repay and stop lending or charge higher - in which case the gov may print money leading to inflation or they default and declares it won’t repay certain debts or repay at less than face value