Stabilizing effect of gnt transfer payments

Assume 2 economies: 1- no transfer payments Y1 (Y don’t depend on Y); 2- with transfer payments Y2 (­Y ® ppl personal incomes ® richer ppl ® ¯necessity to pay transfer payments ® downsloping). Assume ¯ W. Y1>Y2 ®the stabilizer in the 1^st economy lower due to increase in multiplier. ¯mpCd ® ¯k.

Conclusions:

1. “Built-in” stabilizers reduce multiplier and therefore curve Δ in Y

2. The more the stabilizers Δ with Y the bigger the stabilizing

the ­mpt ® ­mpw ® ¯k ® ­stabilizer effect (can’t prevent fluctuations only ¯ magnitude)

2. Discretionary fiscal policy

it is the deliberate Δ in tax rates or the level of G in order to influence AD (involves shifting J&W).

Historically gnt prefer to use discretionary policy

*Unofficial: impossible to increase G for desire of president

*Official: there are another goals than AD stimulation (distimulation):

1. AS stimulation (provide>incentives, encourage ­I)

2. Influence the distribution of income (G&T)

3. Manipulation with gnt ownership (Invests in gnt firms & redistributes income)

Influence of discretionary fiscal policy on Y:

1. Δ in Gexp: as ­G ­Y ®J1; Δ Y=k*ΔJ (G). Δ in Gexp give the full multiplied Δ in Y (rise). Kg – gnt expenditure multiplier-full multiplier. Kg=1/mpw=1/(1-mpc)

2. Δ in tax revenues: the ¯T the ­ Income. Part of the income will be saved®S­®W1->W2->W3 (due to increase in savings). Δ in taxes don’t give the full-multiplier effect. Ktax=Kfull-1.

3. Equal Δ in both gnt exp-re & tax revenues: Assume both ­G & T revenues­ (equal ­). As T­ Income¯®S¯®W->W1->W2. Δ Y=/ac/-/bc/; /ac/=Kg*ΔGe; /bc/=(Kg-1)*ΔT. Δ Y=Δ T(Δ G). Equal increase in both G&T leads to the same increase in Y. In other words, balanced budget multiplier=1

Conclusions:

1. Δ in gnt exp are more strong way to affect Y, than Δ in taxes

2. Discretionary fiscal policy is a stronger more rapid weapon than automatic fiscal policy stabilizers, because:

   1. “Built-in” stabilizers can only reduce the magnitude of fluctuations in the economy, whereas discretionary fiscal policy may prevent fluctuations

   2. Discretionary fiscal policy may increase Y during recession &decrease it during boom

There are a lot of advantages of fiscal policy, however, there are also DISADVANTAGES.

3. Effectiveness of fiscal policy

AUTOMATIC FISCAL STABILIZERS

Possible side-effects (negative effects):

1. High tax rates in boom period may discourage ppl to work & firms to invest in future

2. High unemployment benefits in the recession periods may increase equilibrium unemployment (some ppl prefer to live on benefits)

3. High social benefits in the recession may create a so-called “poverty trap”

“Poverty trap” – discourage of poor ppl from working &getting a better job, because any extra income will be largely taken away in taxes.

4. Fiscal drag – tendency of automatic stabilizers to reduce the recovery of the economy from recession & to decrease the effectiveness of discretionary fiscal policy. ­G®­J®­Y (­T, ¯G); ¯size of multiplier; ¯magnitude of recovery

DISCRETIONARY FISCAL POLICY

Difficulties connected with the fiscal policy providing:

1. Impossibility of resulting Δ in AD because Δ in G&T may influence other components of W&J

2. Impossibility to determine exactly the size of the multiplier & accelerator coefficient ®resulting Δ in AD (it’s impossible to determine apw & mpw as behavior of ppl is unpredictable (we are rational consumers))

3. “Time lags” (gaps) – (Multiplier process takes time for Δs in W, J to be reflected in Y, Out & Em Consumption, firms, Gnt may not respond immediately to new situations.) During the long period between gnt decisions about Δs in T&G &final reaction of Y on gnt policy other events may occur ® may require the opposite fiscal policy.

4. Political problems – political aims may influence the direction of fiscal policy. E.g. election: they promise ¯T&­G in order to win.

Possible adverse side-effects of discretionary fiscal policy:

1. “Crowding-out” effect (­G, money and resources are taken from private sector)

2. Growing gnt debt (impossible to ¯G; G­from year to year®national debt­)

3. Disincentives – when gnt increases taxes (disincentive of ppl to look for job & firms don’t invest ® the ¯Y the ¯ business activity; the more gap between real production & amount of money).

4. Cost-push inflation (the ­T ® ­ in costs of production)

5. Decrease in social security, when gnt ¯G.