Chapter 25 – Fiscal Policy 15
3.
a. the income/spending multiplier = 1/(1-0.75) = 4
∆Y = mult × ∆G
∆Y = 4 × 40 million
∆Y = 160 million
b. the tax multiplier = - 0.75 (4) = -3
∆Y = -3 × ∆T
∆Y = -3 × 40 million = -120 million
c. The net effect of the two policies is:
∆Y
(a + b)
= 160 million – 120 million
∆Y
(a + b)
= 40 million
Yes, it expanded output by 40 million
d. A balanced budget rule means that one can’t respond to severe emergencies, such
as a natural disaster, war, or deal with a severe recession. Because the multiplier is
only equal to one, it provides a fairly weak stimulus.
4.
a. The biggest deficit was created during the Obama years, when the government
responded to the deep economic crisis of 2008 with large increase in spending and
tax cuts; this raised the government deficit. However, if we look at the years before
2008, the Republicans (Reagan, G. Bush Sr., G.W. Bush Jr.) appear to be the big
spenders, with their accumulation large deficits.
b. The emergence of the huge deficits under Reagan, G. Bush Sr., G.W. Bush Jr., and
Obama could be from increasing government outlays (G and TR), and/or cutting
taxes (T). The surpluses under Clinton could be from cutting government outlays (G
and TR), and/or raising taxes (T).
c. No, changes in discretionary fiscal policy are not sufficient in explaining the
emergence of deficits and surpluses, because a recessionary economy could trigger
automatic stabilizers (increases in G and TR, and falling tax revenues), whereas a
booming economy could bring forth increases in tax revenues and cuts in
government outlays. Indeed, the figure of the U.S. real GDP growth shows a deep
recession in 1981-82, which could help explain the emergence of deficits in the early
Reagan period. And the figure shows strong growth rates in the late 1990s, which
could help explain the emergence of surpluses under Clinton.
d. The economy under Clinton could have boomed for other reasons, such as the
increased investor and consumer confidence, leading to increases in investment
and
consumption spending. These could have outweighed the contractionary effect of
his fiscal policies. The surpluses came about not only from the tax increases of his
discretionary policies, but also from the booming economy, which brought in
increases in tax revenues as the automatic stabilizers kicked in