Adobe Systems Fiscal Policy 1 Economic Policy Fiscal Policy Adobe Systems Fiscal Policy 2 Fiscal Policy ̶Stabilization policy ̶ ̶Concepts of fiscal policy ̶ ̶Theories: Keynesian vs. neo-classical view ̶ ̶FP during crisis ̶ ̶Public debt ̶measurement ̶ ̶debt and deficit dynamics ̶ ̶how to reduce the debt burden ̶ ̶Fiscal rules Adobe Systems Fiscal Policy 3 Stabilization Policy ̶aim: maintain a healthy level of economic growth and minimal price changes; to smooth the economic cycle Adobe Systems Fiscal Policy 4 Stabilization Policy Adobe Systems Fiscal Policy 5 Stabilization Policy Adobe Systems Fiscal Policy 6 Stabilization Policy Adobe Systems Fiscal Policy 7 Three key facts about economic fluctuations ̶Fact 1: Economic fluctuations are irregular and unpredictable ̶ ̶Fact 2: Most macroeconomic quantities fluctuate together ̶e.g., investment, unemployment, consumption ̶ ̶Fact 3: As output falls, unemployment rises Adobe Systems Fiscal Policy 8 Concepts and measurements ̶Fiscal policy (FP) – set of decisions and rules regarding taxes and public expenditures for purposes of smoothing the fluctuations of economic cycle in order to keep unemployment close to its equilibrium value and avoid the build-up of deflationary and inflationary pressures (Samuelson, 1948) ̶Theoretically inspired by J.M. Keynes ̶ ̶Now in many countries the key point of FP is public debt sustainability. Adobe Systems Fiscal Policy 9 Fluctuations in output and the size of government in the US (1870–2015) Adobe Systems Fiscal Policy 10 Public expenditures in various countries (% of GDP) Adobe Systems Fiscal Policy 11 Keynesian view: AS – AD model ̶macroeconomic model that explains price level and output through the relationship between AD and AS ̶ ̶aggregate demand ̶total amount of demand for goods and services produced in the economy ̶ ̶combinations of price level and level of output (GDP) ̶ ̶AD slopes downward The Wealth Effect (when prices fall consumers are wealthier which encourages to spend more) The Interest-Rate Effect (lower price level reduces the interest rate which encourages greater spending on investment goods) The Exchange-Rate Effect (lower interest-rate depreciate the real exchange rate which stimulates exports) ̶ Adobe Systems Fiscal Policy 12 Keynesian view: AS – AD model ̶long-run aggregate supply ̶determines the quantity of goods and services supplied in the long run ̶ ̶in the long run it depends on labour, capital, natural resources and technology ̶ ̶short-run aggregate supply ̶combination of price level and level of goods and services supplied in the short run ̶ ̶SRAS slopes upward The Sticky-Wage Theory (nominal wages are slow to adjust, or are „rigid“ in the short run) The Sticky-Price Theory (prices of some goods and services are slow to adjust in the short run) The Misperceptions Theory (lower price level causes misperceptions about relative prices; these misperceptions induce suppliers to respond to the lower price level by decreasing the quantity of goods and services supplied) Adobe Systems Fiscal Policy 13 Keynesian view: AS – AD model Adobe Systems Fiscal Policy 14 Economic Fluctuations in AS – AD model ̶suppose a wave of pessimism in the economy ̶ ̶people lose confidence in the future Þ households cut back on their spending Þ Þ firms put off buying new equipment Þ ̶fall in AD Þ decrease of output Þ Þ decrease in prices Adobe Systems Fiscal Policy 15 Economic Fluctuations in AS – AD model Adobe Systems Fiscal Policy 16 The role of government in AS – AD model Adobe Systems Fiscal Policy 17 Multiplier ̶The US government buys $20 billion of goods from Boeing => increase in employment and profits of Boeing. ̶ ̶Workers and firm owners see higher profits, they respond to this increase in income by raising their own spending. ̶ ̶Increase in government spending => increase the demand for the products of many firms in the economy. ̶ ̶Multiplier = „The additional shifts in aggregate demand that result when expansionary fiscal policy increases consumer spending“. ̶ ̶ Adobe Systems Fiscal Policy 18 The Crowding-Out Effect ̶increase in government spending => increase in government deficit => increase in interest rate => decrease in private investment ̶ ̶The crowding-out effect = the offset in aggregate demand that results when expansionary fiscal policy raises the interest rate and thereby reduces investment spending Adobe Systems Fiscal Policy 19 The neoclassical critique ̶Critique of the multiplier ̶Full financial crowding-out ̶ ̶Supply rigidity ̶Fiscal expansion ̶Rise in the interest rate => penalizes private investment ̶ ̶Fiscal policy effectiveness is limited in time (data shows that multiplier is close to zero after one year) Adobe Systems Fiscal Policy 20 Public budget ̶Public budget is a document that specifies the origin and volume of both income (“receipts”) and intended spending over a certain horizon (usually a year) ̶Public budget ̶Budget of central government ̶ ̶Budgets of local governments ̶ ̶Functions: allocation, redistribution and stabilization Adobe Systems Fiscal Policy 21 Public budget ̶Revenue: income from direct and indirect taxation, social contributions, income from public assets, income from provision of public services and, possibly, income from disposal of public assets ̶ ̶Spending: defence, police, justice, education, research, support to the economy, social policy, health, foreign policy, development assistance, etc. ̶ ̶Budgets for different level of government, cities to central government Adobe Systems Fiscal Policy 22 Public budget ̶The fiscal (budgetary) balance – difference between income and expenditure ̶ ̶Fiscal (budget) surplus Can be used to pay down public debt or invested ̶ ̶Fiscal (budget) deficit ̶ Adobe Systems Fiscal Policy 23 Various degrees of public finance centralization Adobe Systems Fiscal Policy 24 Budget imbalance ̶Budget balance = income – expenditures: surplus (+) or deficit (-) ̶ ̶Central or general government balance ̶ ̶Financial (overall) balance (= net lending); includes net interest payment ̶ ̶Primary balance: excluding net interest payments ̶ ̶Cyclically-adjusted (structural) balance: excluding cyclical balance => FP stance ̶ ̶FP stance expansionary contractionary ̶ Adobe Systems Fiscal Policy 25 Budget balance in the Czech Republic Adobe Systems Fiscal Policy 26 Adobe Systems Fiscal Policy 27 Discretionary FP vs. automatic stabilizers ̶Discretionary FP includes changes in government spending and taxation that need specific approval (usually requires legislative action) => risk of time lags ̶ ̶Automatic stabilizers increase (decrease) budget deficits during times of recession (booms) without specific new legislation => no time lags: e.g., unemployment insurance program, progressive income taxes Adobe Systems Fiscal Policy 28 Automatic stabilizer (Czech Republic) Expenditure 2008 (bil. euro) 2009 (bil. euro) y/y change The state budget 43 47 8% Pensions 13 13,6 9% Unemployment benefit 0,3 0,6 112% 2008 2009 GDP (y/y change) 2,5% -4,1% Unemployment 5,4% 8,7% Adobe Systems Fiscal Policy 29 Empirical assessment of fiscal multipliers ̶Effectiveness of fiscal policy depends on the amount of fiscal multiplier ̶ ̶Studies lead to wide range of estimates for fiscal multipliers from less than zero to more than four ̶ ̶ AuerbachSummary Adobe Systems Fiscal Policy 30 FP during the 2008-2009 crisis ̶Arguments in favor of 2009 stimulus: ̶Risk of depression (recession with a decline of GDP more than 10 %) ̶ ̶Ineffectiveness of monetary policy (transmission through financial system clogged, in addition to zero band) ̶ ̶Exceptional effectiveness of fiscal policy because of: ̶General excess supply ̶ ̶Excess savings and flight to safety resulting in ultra-low bond rates ̶ ̶Focus of agents on short-term horizon, credit constraints ̶ ̶Symmetric character of shocks, therefore, gains from coordinated action Adobe Systems Fiscal Policy 31 FP during the 2008-2009 crisis - USA Adobe Systems Fiscal Policy 32 FP during the 2008-2009 crisis Adobe Systems Fiscal Policy 33 CS: Trade constrains the use of fiscal policy ̶trade with other countries constrains the ability of FP ̶ ̶France ̶1980: weak economic growth ̶ ̶1981: François Mitterrand won the presidential election ̶ program to stimulate aggregate demand through increased government spending and tax cuts ̶ ̶ Adobe Systems Fiscal Policy 34 CS: Trade constrains the use of fiscal policy ̶The French budget balance negative ̶ ̶German budget balance remained close to balance ̶ ̶The French stimulus spilled over to other countries (imports were higher) ̶ ̶The French stimulus increased German export => German GDP ̶ ̶ ̶ Adobe Systems Fiscal Policy 35 Fiscal policy in 1960s in the USA ̶1958 – recession ̶GDP -0,7 % ̶ ̶U 6,8 % ̶ ̶1960 – slowdown ̶GDP 2,6 % ̶ ̶U 6,6 % ̶ ̶New Economics ̶Kennedy, L. Johnson => decrease in taxes (20% reduction in personal tax; 10% reduction in corporate tax) ̶ ̶GDP, employment growth; U decline ̶ ̶taxes remained reduced, increase in G => inflation Adobe Systems Fiscal Policy 36 Reference textbook ̶Benassy-Quéré, A. et al. Economic Policy: Theory and practise. Oxford University Press, 2010. Chap. 3 – 3.2.1 Adobe Systems Fiscal Policy 37