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Lecture 6

ECO1102 Lecture 6: Week 7_ March 2&7

4 Pages
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Department
Economics
Course Code
ECO1102
Professor
David Gray

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Description
March 7 Fiscal policy Should fiscal policy be used to stabilize the economy? Should govt wait for the economy to correct itself or should it use fiscal policy to stabilize the economy? Problem 1: Fiscal policies are often educated guesses Problem 2: Time lags between the problems Are identified Information lag: understanding the current economy When policies are chosen Analysis lag: deciding on the appropriate policy When policies are implemented Formulation lag: passing the required legislation When policies take effect Implementation lag: affecting the economy Often cause fiscal policy to be ineffective or even harmful Automatic stabilizers Automatic stabilizers are changes in taxes or govts spending that offset economic fluctuations without policymakers having to take deliberate action Stimulate AD when the economy contracts Dampen AD when the economy expands Examples: Taxes fall automatically in recessions as incomes falls, which prevents AD from contracting as much The progressive nature of income taxes means that higher tax rates apply as earnings rise, which puts a check in overall spending and AD In recessions, more people apply for public assistance so that govt spending Discretionary fiscal policy Policymakers can also use discretionary fiscal policy to respond to economic conditions Information, analysis, formulation and implementation lags can reduce the effectiveness of such policy Discretionary policy may be used when automatic stabilizers are unsuccessful in correcting the economy Eg: Politicians may cut taxes in response to recessions But tax cuts are not free because govt must find a way to make up for the lost tax revenue Ricardian equivalence predicts that people will not change their behaviour (AD will not increase) if there are tax cuts but no decrease in spending
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