Student Notes 12:

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Rose-Hulman Institute of Technology Department of
Humanities Social Sciences / K. Christ SL 151,
Principles of Economics
Student Notes 12 Macroeconomic Policy, Part 2
-- Fiscal Policy
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Fiscal policy Can policy makers stabilize the
economy?
The Circular Flow Model
Goods and Services
Output Markets
Payments
Business Sector
Household Sector
Factor Payments
Input (or Factor) Markets
Factors of Production (or Production inputs)
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Fiscal policy Can policy makers stabilize the
economy?

• Spending and financing decisions of the federal
  government

• Implemented by Congress in conjunction with the
  President
• Subject to noticeable lags in implementation

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Fiscal Policy and the Macro Economy
Aggregate Economy
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The Consumption Function and Spending Multipliers

Aggregate Demand Identity
Total Income
Net Taxes
Keynesian Consumption Function
Marginal Propensity to Consume
Autonomous consumption
Disposable (After-Tax) Income
By assumption
Spending Multipliers
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Fiscal policy Some additional considerations
Timing and lags
q
(1) (2) (3)
Recognition Implementation Effectiveness
Crowding out effects
q
If government debt-financed spending contributes
to rising interest rates, then there may be
detrimental effects on private investment.
Perfect foresight (forward looking behavior)
q
If consumers understand that recessions and booms
are temporary, their consumption spending will
be less sensitive to changes in current income.
(This observation calls into question the
assumption implicit in the typical Keynesian
consumption function).
Central bank accommodation of fiscal policy
q
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Empirical regularity 1 Okuns law output and
unemployment An empirical relationship between
GDP Growth and Unemployment Rate
DReal GDP 3.18 - 1.90 DUnemployment Rate
1960 - 1998
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Empirical regularity 2 The Phillips curve
inflation and unemployment
Based on annual data.
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Empirical regularity 2 The Phillips curve
inflation and unemployment
Based on annual data.