McConnell Economics, Chapter 12

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Jin+Guice
Posts: 703
Joined: Sat Jun 30, 2018 8:15 am

McConnell Economics, Chapter 12

Post by Jin+Guice »

Discussion of the curriculum McConnell, Brue, Flynn Economics text, chapter 12.

Jin+Guice
Posts: 703
Joined: Sat Jun 30, 2018 8:15 am

Re: McConnell Economics, Chapter 12

Post by Jin+Guice »

Chapter 12 discusses the very timely subject of government fiscal policy

The government may attempt to implement expansionary or contractionary fiscal policy depending on current economic conditions. When trying to stimulate the economy during a recession the government may increase spending or decrease taxes. Due to the various multiplier effects increasing spending will increase aggregate demand more than decreasing taxes (tl;dr: some of the tax reduction is saved by consumers). When trying to decrease inflation through contractionary policies the government can either increase taxes or decrease spending (again decreasing spending will have a larger effect than an equal increase in taxes).

If the government reduces taxes or increases spending it will incur a deficit. It can finance this deficit through borrowing from the public (by minting bonds) or printing new money. When to government borrows money, it risks driving up the interest rate. This will decrease private borrowing to an extent and partially offset the effect of the government spending increase/ tax decrease. If the government prints new money, the "crowding out" of private borrowing is avoided but the risk of inflation is increased.
If the government is attempting to deploy a contractionary policy, it will cause a budget surplus. The extra money can be used to either reduce debt or it can be "idled" or taken out of circulation for a period. Paying off debt will put a portion of the funds back into the economy and reduce the anti-inflationary effects of increases taxes/ decreasing government spending. Thus "impounding" the money or taking it out of circulation is more effective at reducing inflation.

Government policy has some automatic stabilizing effects built into it that result from the structure of the economy. Tax revenue will automatically increase during an economic expansion and decrease during a recession. To evaluate whether a government is actively pursuing an expansionary, contractionary or neutral fiscal policy, it's necessary to remove the natural changes that occur to tax revenues due to shifts in GDP. This is done by evaluating what government tax revenues would have accrued at full-employment under the GDPs for two different years. The method used to calculate this is described in detail in section 12.2 of the book.

The government lacks perfect control over fiscal policy. Time lags between a change in the business cycle and the reporting of statistics that indicate the change can delay government response to these changes. Democratic governments sometimes lack the political direction to act quickly and self-interested politicians may attempt to game the system by taking measures that boost economic indicators in the short-term near election time. 

Government fiscal policy also faces the "crowding out" effect, inflationary difficulties and the net export effect. Crowding out occurs when the government raises the interest rate to finance expansionary policies and thus decreases private borrowing. This decrease will cancel out some of the effect of increased government spending. In the upward sloping portion of the aggregate supply curve, an increase in aggregate demand will also cause an increase in the overall price level, aka inflation. The increase to real GDP will not be as great if the economy is in the upward sloping portion of the aggregate supply curve. 

The net export effect is also caused by the change in interest rate. As interest rates increase in the Untied States*, foreign capital is attracted. Foreigners must exchange their currency for dollars, which drives up the demand for dollars, causing American goods sold in dollar denominated prices to be more expensive to foreigners. This drives down exports and makes foreign goods cheaper for Americans, driving imports up. This leads to a decrease in net exports with cause the economy to contract.
*I'm using the U.S. since I'm American and the text is Americacentric, but this will work substituting any nation as the "local" nation.

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