Fiscal Multiplier

6 Key excerpts on "Fiscal Multiplier"

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  eBook - ePub

  Macroeconomic Analysis and Policy

  A Systematic Approach

  • Joshua E Greene(Author)
  • 2017(Publication Date)
  • WSPC

    (Publisher)

  3. The composition of expenditures can also affect the economy. Devoting a high share of expenditure to transfer payments, such as public pensions, or poorly targeted subsidies (such as subsidies for motor fuels), may pre-clude spending for maintaining and expanding public infrastructure. High interest payments, the result of heavy deficit spending in the past, may limit funds for education and health care.

  4. The composition of budget financing also matters. Relying heavily on foreign financing often exposes the budget’s debt service obligations to exchange rate risk, particularly in developing and emerging market countries that can only borrow externally in foreign currency. Extensive borrowing from the central bank, which leads to money creation, can prove inflationary, while extensive bank borrowing may crowd out financing for private investment if government borrowing represents a large share of total bank lending.

  I. IMPACT OF FISCAL POLICY ON MACROECONOMIC ACTIVITY: AGGREGATE DEMAND

  As noted in Chapter I, fiscal policy can affect the level of economic activity. How much the economy expands or contracts depends on the Fiscal Multiplier. The Fiscal Multiplier is the ratio of the change in nominal GDP to a change in revenues or expenditures that causes it. Fiscal Multipliers arise because changes in revenues and expenditures affect aggregate demand. Tax cuts leave more after tax income available for consumption or investment, while higher expenditures raise spending directly (if government increases its purchases) or indirectly (if higher government benefit payments raise consumption). Fiscal Multipliers typically increase over time, as the spending of one person or firm becomes the income of other firms or persons who, in turn, use that for further spending. Eventually, the size of the multiplier reaches a practical limit, as taxes and other withdrawals (e.g., spending for imports) gradually reduce the increment to spending from each additional receipt of income.

  The size of the Fiscal Multiplier depends on a variety of factors. These include:

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  eBook - ePub

  Economics for Investment Decision Makers

  Micro, Macro, and International Economics

  • Christopher D. Piros, Jerald E. Pinto(Authors)
  • 2013(Publication Date)
  • Wiley

    (Publisher)
• Capital spending plans take longer to formulate and implement, typically over a period of years. For example, building a road or hospital requires detailed planning, legal permissions, and implementation. This is often a valid criticism of an active fiscal policy and was widely heard during the U.S. fiscal stimulus efforts in 2009–2010. On the other hand, such policies add to the productive potential of an economy, unlike a change in personal or indirect taxes. Of course, the slower the impact of a fiscal change, the more likely other exogenous changes will already be influencing the economy before the fiscal change kicks in.
The aforementioned tools may also have expectational effects at least as powerful as the direct effects. The announcement of future income tax rises a year ahead could potentially lead to reduced consumption immediately. Such delayed tax rises were a feature of U.K. fiscal policy of 2009–2010; however, the evidence is anecdotal because spending behavior changed little until the delayed tax changes actually came into force.
We may also consider the relative potency of the different fiscal tools. Direct government spending has a far bigger impact on aggregate spending and output than income tax cuts or transfer increases; however, if the latter are directed at the poorest in society (basically, those who spend all their income), then this will give a relatively strong boost. Further discussion and examples of these comparisons are given in Section 4 on the interaction between monetary and fiscal policy.

3.2.2. Modeling the Impact of Taxes and Government Spending: The Fiscal Multiplier

The conventional macroeconomic model has government spending, G , adding directly to aggregate demand, AD , and reducing it via taxes, T ; these comprise both indirect taxes on expenditures and direct taxes on factor incomes. Further government spending is increased via the payment of transfer benefits, B