2. The net effect of exports reduces the effectiveness of fiscal policy: Although the initial effect of contraction policy is to reduce nominal gross domestic product (GDP), which is defined as gross domestic product (GDP) valued at current market prices, this often ultimately leads to sustainable economic growth and more fluid business cycles. The policy of contraction occurred especially in the early 1980s, when then-Federal Reserve Chairman Paul Volcker finally halted the rise in inflation of the 1970s. At their peak in 1981, target federal funds interest rates were approaching 20%. Measured inflation rose from almost 14% in 1980 to 3.2% in 1983. This process will continue again and again. When does it stop? If we add everything that has been recorded and it corresponds to 20 ( 4 + 3.2 + 2.56 + …+…+…+…+.. = 20), then there is nothing left to spend and the process stops. When you do this, you will get the following global changes: Let`s use the same data that we used here to see HOW MUCH tax should be changed when using tax policy.
One would think that if public spending were increased by $100, GDP would increase by $100, BUT THAT IS NOT THE CASE! What we will learn in this chapter is that a small initial increase in spending leads to a much larger change in GDP. This is called the MULTIPLIER EFFECT. A small initial change in spending will result in a larger change in GDP as the change in spending trickles down to the economy. How does this inflation, which results from an increase in the AD, affect the size of the multiplier? Or what happens to the evolution of public spending that is necessary to achieve full employment if we allow inflation? Without inflation and with a MBM of $0.8, GDP will increase by $100 if we increase public spending by $20. The multiplier is 4. This moves AD from AD1 to AD2 in the two diagrams above. In Chart a) without inflation, equilibrium GDP rises from $400 to $500. But in chart (b) with inflation, the same horizontal change in AD increases GDP from $400 to just $460. From the same change in government spending ($20), GDP increases slightly. The multiplier is smaller. This will be a fiscal policy aimed at reducing unemployment or inflation.
BIP = C + I + G + Xn 400 Look at the graph on the right and the formula above. You can see that this economy is in equilibrium, producing a production of $400, but if there were full employment, a real GDP of $500 could be achieved. Therefore, this economy has a problem with unemployment and does not produce as much as it could. What is the appropriate fiscal policy that the government could use to push this economy to full employment? We know that the government could increase public spending and/or cut taxes to increase the AD and achieve full employment. Let us focus here only on government spending. Contraction policy is a monetary measure that refers either to a reduction in public spending – especially deficit spending – or to a reduction in the rate of monetary expansion by a central bank. It is a kind of macroeconomic tool to combat rising inflation or other economic distortions caused by central banks or government intervention. The policy of contraction is the exact opposite of expansive politics.
What would happen if we increased G by $100 AND T by $100? If we increase G, it will increase GDP, but if we increase T, it will reduce GDP. If we do both, what happens? We therefore already know that in the event of unemployment, the appropriate budgetary policy would be to increase public spending and/or reduce taxes. Here we will discuss HOW MUCH government spending should be increased or taxes reduced? GDP (income) C S APC APS MPC MPS $ 0 $40,100 120,200 200 300 280,400 360,500,440 As expected, as the economy`s GDP (income) increases, household consumption increases. GDP and consumption are directly linked. If we had to graph this consumption data, we would get: No, the poor family would most likely spend the entire $10,000 and Bill Gates would probably not spend any of the extra income. Thus, the MPC of the poor family would be very high or equal to 1, and the MPC of Bill Gates would be very low or equal to 0. Thus, as GDP or income increases, MPCs are expected to decrease or decrease, and MSDs are expected to increase. This means that the slope of the consumption chart is expected to become smaller (flattened) as GDP increases. So let`s go back to our example and see what the government can do to reduce unemployment without creating a (larger) deficit. Use these diagrams to answer the following questions. This multiplier process helps explain why cities want the Superbowl, political conventions or Olympic Games to take place in their city. Not only is it because these activities attract people who spend money and create jobs, but more importantly, this initial change in spending initiates the multiplier process, so that the overall economic effect and the number of jobs created are much greater than the initial spending on these activities alone.
3. The OPERATIONAL BACKLOG is the period of time that elapsed between the policy change and its impact on the economy. c. multiplier and AS/AD chart: $20 billion rating in class Example: See explanation below Contractionary monetary policy is driven by increases in the various policy rates controlled by modern central banks or other means that generate money supply growth. The goal is to reduce inflation by limiting the amount of active money circulating in the economy. It also aims to suppress unsustainable speculation and capital investment that may have triggered previous expansionary measures. Note that if the income is equal to $0, there is still consumption ($40 billion). This is called “autonomous consumption”. It is consumption that is not related to income. Think about what a $0 GDP means. If an economy`s GDP or income was $0, it means that nothing was produced there. If an economy produces nothing, would there still be consumption? Yes, but how? They were consuming goods that had been saved from earlier periods.
Of course, a GDP of $0 is a ridiculous concept, but there are two components of household consumption: (1) autonomous consumption, which is not related to income, and (2) induced consumption or consumption, which is directly related to income. If you remember your Calculations in Grade 8, you will realize that our formula for MBM is actually the slope of the consumption graph. b. Bogus example of $20 billion (DO YOU KNOW THAT!) Suppose MPC = 0.8 and I increase by $20 billion 3. The displacement effect may be due to fiscal policy. Contraction policies are often linked to monetary policy, with central banks such as the Federal Reserve being able to implement this policy by raising interest rates. The objective of an expansionary fiscal policy is to reduce unemployment. Therefore, the instruments would be an increase in public spending and/or a reduction in taxes. This would shift the AD curve to the right to increase real GDP and reduce unemployment, but it could also cause some inflation.
So let`s go back to our example and see what the government can do to reduce unemployment without creating a (larger) deficit. What change in the balanced budget (change in government spending and taxes of the same amount and in the same direction) could the government undertake to increase GDP by $100 in this economy and thus achieve full employment? To make it easier for us, we will discuss “flat taxes” and not the much more frequent income tax. A flat tax is a “tax per person” and does not change with income. For example, if the flat tax was $500 per person, I would have to pay $2,000 for my family of four, regardless of my income. .