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Economic Presentation: Fiscal Policy, Government Budget, and Debt and Deficit

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Daphne Richard

on 10 January 2014

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Transcript of Economic Presentation: Fiscal Policy, Government Budget, and Debt and Deficit

This political cartoon draws comedy on the GST (Goods & Services Tax) cut, from 7% to 6% in 2006, and another 1% cut in 2008. Each percent draws in about $7 billion. As such, the GST cuts have deprived the federal government of an annual $14 billion. The lost money could have been used by the government to reduce the annual deficit.
What is Fiscal Policy ?
Types of Fiscal Policies
Expansionary Fiscal Policy:

Contractionary Fiscal Policy:

Discretionary Fiscal Policy:

Automatic Fiscal Policy:
automatic stabilizers
fiscal policy
- changes in taxation and government spending to influence changes in the economy

Fiscal policy is also the utilization of the federal budget to meet macroeconomics goals such as full employment, long-term economic growth, and price level stability.

The Multiplier Effect
Government Budget: Who creates it and what makes it up?
Debt and Deficit
Economics Presentation:
Fiscal Policy, Government Budget, and Debt and Deficit

Expansionary Fiscal Policy
Contractionary Fiscal Policy
it is a policy used in periods of high inflation or out of control expansion
a period out of control expansion will cause an inflationary gap


inflationary gap= the amount by which real GDP exceeds potential GDP
to close this gap a government will decrease government spending and/or increase taxation (injections<leakages)
if there is a tax increase that will mean that consumers will have less disposable income, therefore they will invest less into the economy causing it to contract
a decrease in government spending means the government will not be investing therefore public services/programs will be cut, this will decrease aggregate demand as well as cause the economy to contract

Discretionary fiscal policy
A deficit is how much money is owed in a particular year
A debt is the total amount of money owed since the nation’s “birth”

What are they?
Automatic Fiscal Policy
How Does the Debt Affect the Deficit?

it is a fiscal policy used in a time of recession, to stop contraction of the economy
a recession will cause a recessionary gap
The interest on debt is added to the annual deficit
If the nation fails to meet the cost of interest, then investors will lose confidence, and choose not to invest in the nation in the form of treasury bonds, which is a source of income the government relies on to aid in paying off the deficit
Deficit

A deficit is how much money is owed in a particular year
A deficit occurs when the government’s spending is greater than the revenues
(Ex. The Government of Canada imports $20 million worth of imports, and exports $15 million worth of goods. As the imports are greater than the exports, a deficit of $5 million occurs )

Advantages
In the short term, a deficit benefits the nation, because money has been invested into the economy - for example, education, national post, etc - and thereby stimulating it, as production and employment increase

Disadvantages
At the end of the fiscal year the accumulated deficit is added to the already existing debt, thereby, increasing the debt

How are they paid off?
Treasury bills will be sold by the government in order to raise funds to pay the deficit
These bills are bought by investors
Though the government will have eliminated the deficit, the debt will not decease. This is due to the government having to refund the Treasure Bonds by the agreed date.
Taxes
Taxes are a source of revenue for the government, and as such, taxes may be raised in order to generate more revenue, in order to decrease the deficit, or, preferably, achieve a balanced budget
Indirect taxes - sales tax, goods and services tax
Direct taxes - income tax, property tax

Debt
A debt is the total amount of money owed since the nation’s “birth”
Debt is a result of the government borrowing money to cover annual deficits

Some nations choose to impose a a debt ceiling, which is a limit on how much money the government can borrow, however, in countries such as the USA, debt ceiling can be raised when the US nears the limit
the debt ceiling is increased to avoid missing interest payments to bondholders, as this would lower the country's credit score

Current Canadian debt is about $1.2 trillion

Advantages
The debt accumulated is usually a result of government injections into the economy, and as such, the debt can be seen as a financial investment that will later yield capital.
(Ex. A student in university will borrow money in order to pay for tuition. When the student graduates, they will have accumulated a debt, however, they will earn a higher income when they enter the work force, due to their degree, and as such, the debt can be seen as a financial investment)

Disadvantages
The more money owed, the more interest payments need to be made , and as such, a significant amount of the debt is accumulated interest
Or, as the debt increases, the government may choose to cut social programs, and instead, reallocate the money to paying off the debts and deficit
As the debt increases, the government may have to increase its taxes in order to generate more revenue, however, the extra revenue will be used to pay debts rather than to increase government programs (ex. Healthcare, welfare, etc)
If taxes are increased, then the population will have less disposable income. Less income will negatively affect the aggregate demand. As the aggregate demand for goods and services decreases, GDP will decrease. If the GDP continues to decrease - for two consecutive quarters - a recession may occur
recessionary gap = the amount by which the potential GDP exceeds real GDP
to close this gap, a government will increase government spending and/or decrease taxation(injections > leakages)
if there are tax cuts this will mean consumers will have more disposable income, so they will invest more in the economy, causing it to expand.
an increase in government spending means the government will invest more in outlays such as transfer payments, expenditures on goods and services, and debt interest
this will increase aggregate demand as well as cause the economy to expand
As a result of an increase in government spending and a decrease in taxes aggregate demand shifts to the right from AD0 to AD1. As taxes decrease disposable income increases This causes real GDP to increases from Y0 to Y1. As well price level increases from P0 to P1 and the unemployment rate decreases. Lastly, unemployment rate decreases.

As a result of an decrease in government spending and an increase in taxes aggregate demand shifts to the left from AD0 to AD1. As taxes increase disposable income decreases. This causes real GDP to decrease from Y0 to Y1. As well price level decreases from P0 to P1 and the unemployment rate increases. Lastly, unemployment rate increases.
The following digram shows when contractionary fiscal policy would be implemented upon the business cycle.
The following diagram shows when Expansionary Fiscal Policy would be implemented upon the business cycle.
This political cartoon illustrates a form of action the government may choose to take in order to reduce the deficit, which is to raise taxes. Raising taxes would help to decrease the deficit however, the population will have less disposable income
Note: fiscal policy is implemented through government discretion and/ or automatic stabilizer
a fiscal policy which is implemented by automatic stabilizers which function according to the current economic climate
Automatic Stabilizers
they act counter cyclically to or against the current economic trend
are changes that occur automatically occur when there are changes in employment, income and, output.
they have a stabilizing affect on the economy

Ex) Corporate Profits, Progressive income taxes, and The Unemployment insurance program
What Makes Up a Federal Budget?

Revenue:
personal income taxes
corporate income taxes
indirect taxes
investment taxes
Outlays:
transfer payments
Expenditures on goods and services
Debt interest

Budget Balance
Budget balance = Revenues - Outlays
a discretionary fiscal policy is a fiscal policy that is implemented through government discretion.
an example of discretionary fiscal policy action is increasing income taxes
Autonomous Taxes
are taxes which do not change according to real GDP.
these taxes are fixed, they can only be changed through government discretion
ex) property tax
Who makes it?
The multiplier effect occurs when there is an injection in the economy, this results in stimulation throughout the economy
the amount of spending that is invested into the economy depends on a households marginal decisions, this is called a household's marginal propensity to consume, basically how much a household can spend
in the same way a households marginal propensity to save is how much a household can afford to save.
this could occur when an expansionary fiscal policy is implemented
Equation to calculate multiplier effect: 1/1 - mpc
Positive aspects: small changes in investment or government spending creates much larger changes in total output and substantial improvements
Negative Aspect: a small decline in business could trigger a larger decline in business activity and create instability
Imagine the government decides to use some of its reserves to build a new bridge. It takes money from the reserves and buys the raw materials and pays the workers. Let's focus onthe salaries to workers.

Say each worker is paid $100. Then each saves $10, and spends the rest on pies. From each worker, the pie shop owner has $90 extra, and let's say she saves $9 of it, and spends $81 on say milk. The farmer receives $81 which started as $100 from the worker, but out of which $19 was saved, $10 by the worker and $9 by the pie shop owner. If the trend continues, say the farmer saves $8.10 and spends $72.90 on seeds...

From the original $100 per worker spent by the government, the worker spent $90, the pie shop owner $81, the farmer $72.10... Therefore the $100 per worker spent by the government hasthus made income grow by more than $100, hence the name multiplier. If at every stage the person earning keeps 10% of what he/she earns (marginal propensity to save = 10%) then the overall effect will be that $100 will increase income by 100*(1/10%) = $100*10 =$1000. The multiplier is 10.
it is a process that begins with, the Minister of Finance,officials of the Department of Finance, and their counterparts in the provincial government consulting each other in long meetings.
the Minister also holds consultations with businesses and consumer groups on a large number of issues
a set of proposals are developed, they are debated about in Cabinet, and then become government policy
finally, a budget plan is presented by the Minister to Parliament, who then debates about it and creates laws to implement it.
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For example...
Canadians getting richer, average net worth tops $400,000
A large corporation decides to build a factory and spends $5 million that goes to electricians, engineers, etc. If MPC is equal to 0.8 meaning each those people will spend 80% of their income on consumer products they will be spending $4 million. The businesses and individuals receiving the $4 million will in turn spend 3.2 million etc.
Therefore if the MPC is equal to 0.8 or 4/5 then the multiplier effect can be calculated as follows
Multiplier= 1/ (1-0.8)=1/0.2= 5

(*in this formula "/" means multiplication)
As the personal net worth of Canadians increase, their disposable income will increase. A larger disposable income will allow consumers to spend more on goods and services
As a result, aggregate demand will increase. This will lead to price levels and real GDP increasing
In the business cycle, a period of expansion will occur.
At this point, the government will implement a contractionary fiscal policy, in which government spending will decrease, and taxation will increase
Negative Multiplier
a withdrawal of income from the circular flow results in a downward multiplier effect on the rest of the economy
withdrawals from the economy could be increased saving, import spending or taxation
this causes contraction of the economy, hence could occur when a contractionary fiscal policy is implemented
OPEC oil production to continue to decline
As a result of the decrease in supply, the equilibrium price of oil will increase, and the equilibrium quantity will decrease
As oil is an input of production in most markets, the prices of most goods and services will increase;
A contraction will occur in the business cycle.
The government will implement an expansionary fiscal policy, in which government spending will increase and taxation will decrease
Daphne
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