Macroeconomics
The long-term serious effect of crowding out is slower economic growth . Recall from Chapter 1 SectionE:ShiftsofthePPC,thateconomicgrowthisreflectedbyanoutwardshiftofthePPCthatresults either from an increase in the economy’s productive capacity because more resources become available, or due to technological advancements. When private investment decreases, capital accumulation or capital stock decreases, hence slowingdown economic growth. In summary, an expansionary fscal policy that includes running a budget defcit could lead to crowding out which in turn has a long-term effect of reducing economic growth . E. Automatic Stabilizers Fiscal policies have lags that prevent them from quickly smoothing out fluctuations in the business cycle. However, some existing laws or policies are non-discretionary (not explicitly done by the government to solve economic problems) and help restore theeconomytoequilibriumwithoutactive involvementofgovernmentsorauthorities.Thesethingsarereferredas automaticstabilizers or built-in stabilizers and include the following: 1. Taxes: Let’sassumethataneconomyusesa progressivetaxsystem .Thismeansthatthetax rate paid increases as income increases (e.g., those who earn less than $10,000 pay 2% in income tax, whereas those who earn more than $10,000 pay 8% in income tax) . Intimesofeconomicdownturn,people’sdisposableincomesdecrease(e.g.,duetopaycuts).If worker A’s income drops from $12,000 to $8,000, the amount of tax worker A pays will automatically dropfrom$960to$160(8%of$12,000vs.2%of$8,000).Thisworksthesame as an increase in worker A’s disposable income; meaning that this automatic change in the amount of taxes paid acts like an expansionary fscal policy where taxes are reduced to stimulate consumption and/or investments, and hence aggregate demand! Note how the
government did not intervene in this case. The progressive tax systemwasalreadysetinplacebefore any changes in the business cycle. Alternatively, in times of economic boom where real GDPishighandmorepeoplearepayinghigherincome taxes, tax revenue increases. This reduces disposable incomes and helps in controlling consumption and preventing inflation from increasing further.
2. TransferPayments: Recallthattransferpaymentsarepaymentsreceivedwithouttheexchange ofagoodorservice,suchaswelfarepaymentsandunemploymentbenefts.Duringrecessions, more people are unemployedand,therefore,receiveunemploymentbenefts.Thismeansthat consumption will drop,buttheroleofunemploymentbeneftswillabsorbsomeofthatimpact astheyactasameansforpeopletospend.Alternatively,intimesofbooms,lesspeoplereceive unemployment benefts because the unemployment rate is usually low. This is basically a reduction in government spending which in turn reduces aggregate demand (shifts AD to the left) and aids in reducing the price levels.
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