Econ notes

10.4 Central Bank Independence - When the central bank is independent, its board and the head of the bank are selected by the government but are appointed for several years o Longer than the government term in office - Central bank manages monetary policy without interference from elected officials o It is not subject to political cycle Government may be tempted to stimulate economy before an election, creating a boom and reducing unemployment rate - An independent bank cannot be used to finance government spending o Good thing as it would not be printing money to buy government bonds 10.5 Rules Versus Discretion - When the central bank is independent, the best macroeconomic policy tool is not controlled by elected officials Why would such an important policy tool be removed from control by elected officials? - Monetary policy under the control of the government is time-inconsistent There are two approaches to policy: rules or discretion - Under a rule, the policymaker specifies what it is going to do in various situation and sticks to its promise - Under discretion, the policymaker chooses the best course of action at every moment of time o Leads to a worse outcome Time Inconsistency 423
CHAPTER 11: FISCAL POLICY Fiscal policy has been decreasing in importance because - So much large government debt limits the government - Fiscal multipliers are small Fiscal Policy Goals: - Promote smooth functioning of the economy - Reduce cyclical fluctuations in output and employment - Redistribute income - Promote economic growth Fiscal Policy Tools: - Government purchases of goods and services - Taxes - Government transfers The menu of possible actions is greater than monetary policy. - Taxes can be fine tuned to promote development in areas or industries - Taxes and transfers used to distribute income towards the poor o Smooth fluctuations of income over time - As income declines in a recession, taxes fall as a proportion of income and so after-tax income falls less Government Purchases of Goods and Services - Consist of government expenses on currently produced goods and services - Provincial govt are the main purchasers of goods and services o They are responsible for heath care and education - Fed govt purchase defense, foreign affairs, federal administration Taxes - Imposed by all levels of government - Main categories are income, consumption, payroll, and property taxes - Income taxes, often called direct taxes are taxes imposed directly on factors of production Government Transfers - Payments to individuals without receiving goods and services - Include employment insurance benefits, welfare, and other income support, old age security, government and veteran pensions and business subsidies Disposable income = earned income - (taxes - transfers)
Automatic and Discretionary Fiscal Policy - Automatic fiscal policy involves changes in taxes and transfers resulting from the business cycle o When economy goes into recession, tax revenue automatically falls as income of both individuals and firms declines o Transfers increase as there are more unemployed people - Discretionary policy involves deliberate changes, decided by the government o During recession government increases spending to support the economy 11.3 Government Expenditure Multipliers The multiplier = 1 1 MPC - Ex. If the marginal propensity to consume is 0.75 then the multiplier is 4 o One dollar of govt spending raises output by 4 dollars Nvm the multiplier is = 1 1 ( MPC MPI ) ∗( 1 t ) - Accounts for imports and taxes 11.4 Deficits and Surpluses Surplus = Revenue - Total spending Deficit= -surplus Primary surplus = Revenue - program spending Federal Reserves, Spending, and Deficits in Canada - Deterioration of our fiscal position stopped with the anti-deficit policy introduced in 1995 - From 1997-2007 we were in a surplus but in 2008 we went into a deficit because of the Great Recession - Fiscal dividend is the reduction in debt interest payments as the government runs a surplus and debt decreases - The reduction in interest payments leads to a faster decline in debt Composition of Federal Revenues and Spending Composition of Federal Government Revenue - The federal government obtains most of its revenue through taxes: o Individual income taxes are the taxes that households pay on their wage and non- wage income o Corporate income taxes are taxes that corporations pay on their profits
o Social insurance contributions are the contributions to Canada and Quebec Pension plans and to employment insurance premiums. They are often called payroll taxes since they are paid at the same time as wages and salaries o The Goods and Services Tax (GST) is an indirect tax paid at each stage of production - Since 1981, total federal revenue has averaged at about 17% of GDP Composition of Federal Government Expenditures - Total expenditure was increasing until 1922, with a peak of over 21% of GDP - It then fell continuously until 2007 when it reached 14.7% of GDP o As a result of automatic stabilizers and discretionary fiscal policy during the Great Recession, the expenditure increased by 1.5% of GDP by 2009 but, by 2012, it returned to the pre-recession share - Surpluses resulted in a decrease in the interest on debt paid - fiscal dividend Cyclically Adjusted Deficit - An economy that has a balanced budget during a recession is in better financial shape than an economy that has a balanced budget during an expansion - This is because during recession surplus falls as automatic fiscal policy kicks in o Tax revenue falls and government transfers increase - The current deficit is in part due to cyclical factors: the cyclically adjusted deficit is now smaller (in absolute value) than actual deficit - The recent trend in adjusted deficit shows the deterioration of Canada's fiscal situation. The cyclically adjusted surplus was positive until 2008, and negative since. In other words, even when the effect of the Great Recession on deficit is correct for, our fiscal position after the Great Recession is worse than before the Great Recession 11.5 Debt Gross and Net Federal Debt in Canada - The debt is the total value of government bonds outstanding - Putting aside changes in the monetary base, we can think of the budget deficit as the yearly flow of government bonds o Value of bonds outstanding increases when in a deficit and decreases in a surplus - When government expenditures are greater than revenue, debt increases - When revenue is greater than expenditures, debt decreases - budget surplus Debt to GDP ratio does a better job of measuring whether fiscal policy is sustainable - Fed govt obtains most of its revenue through taxes and GDP represents the income potentially available to be taxed - Measure debt to income because income represents your ability to make interest payments or repay debt
Gross federal debt is the total dollar value of government bonds outstanding plus superannuation owed by the federal government as an employer plus accounts and interest payable Net federal debt = dollar value of gross federal debt - government financial assets - Assets include currency and deposits, accounts receivable, reserves and other financial assets How Canada Eliminated the Deficit - Canadian debt to GDP ratio rose faster than any other G7 country and reached 100% in 1995 - In 2012 Canada had the lowest debt to GDP ratio among G7 countries How did they get rid of so much debt? - In 1981-82 Canada went through a severe recession and the federal government decided to stimulate the economy - The government went through in detail its spending and made a lot of careful cuts o The US economy was booming so we increased exports which helped - The entire government was in on reducing the debt which made it so successful as it was not only put up to the Minister of Finance - Most important: political will o If the deficit is not seen as severe and important, nothing will be done and it will be overlooked Debt in G7 Countries - The large debts were result of the Great Recession - Governments used aggressive expansionary fiscal policies at the same time as automatic fiscal stabilizers led to large increases of spending over revenue With aging populations and rising health care and pension costs, countries face hard choices: governments must choose among 1. Reducing health care and pension benefits for the elderly 2. Reducing other spending 3. Raising taxes to levels that might significantly reduce economic efficiency
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