🔍
Fiscal Policy and Crowding Out - YouTube
Channel: Marginal Revolution University
[0]
♪ [music] ♪
[13]
- [Alex] In order to work well,
[15]
fiscal policy must be timely,
targeted, and temporary,
[20]
as we discuss
in our previous video.
[23]
But fiscal policy can also be
fully or partially offset
[29]
depending on how central banks,
[31]
businesses, and consumers
respond to fiscal policy.
[37]
First: central banks.
[40]
When a government
increases spending,
[42]
the aggregate demand curve
shifts out,
[45]
which increases inflation.
[48]
Now, central banks
often try to stabilize prices.
[52]
So if fiscal spending shifts
the aggregate demand curve out,
[56]
increasing inflation,
[58]
the central bank might choose
to contract the money supply.
[63]
Contracting the money supply
[65]
means shifting
the aggregate demand curve inwards.
[69]
In other words,
monetary policy could offset
[73]
or reverse
the fiscal policy expansion.
[78]
When a central bank responds
to expansionary fiscal policy
[82]
with contractionary monetary policy,
[85]
we call this a monetary offset.
[89]
But it's not just the central banks
[91]
that respond to changes
in fiscal policy --
[95]
businesses could also act in ways
[98]
that partially offset
a fiscal stimulus.
[102]
For example, if the government
increases spending by borrowing,
[107]
this will tend to increase
the interest rate
[110]
in the loanable funds market.
[112]
And if the interest rate increases,
[115]
businesses may scale back
on their investment.
[119]
So remember that real GDP is
consumption plus investment
[123]
plus government spending
and net exports.
[127]
So when "G" increases,
[131]
we may see a decrease
in "I," investment,
[135]
offsetting the fiscal stimulus
[138]
and weakening the effects
of the multiplier.
[141]
Consumers could also
respond to fiscal policy
[145]
in ways that make fiscal policy
less effective.
[150]
If the government cuts taxes
to stimulate the economy,
[154]
people might then choose
to save the tax cut.
[159]
Now, saving money from a tax cut
actually makes a lot of sense
[163]
if people expect that tax cuts today
[167]
will be matched
by tax increases tomorrow.
[171]
However, if people
save their tax cuts
[174]
instead of spending them,
[176]
then the aggregate demand curve
never shifts out.
[181]
The multiplier will be zero,
[182]
and there will be no systematic
macroeconomic effects.
[186]
Now this scenario is sometimes
called Ricardian equivalence,
[191]
after the 19th-century
British economist, David Ricardo.
[196]
Most economists think
that it's somewhat unrealistic
[199]
to model everyone as fully rational
[202]
and incorporating
their future tax burdens
[205]
when making saving
and spending decisions.
[208]
Tyler claims that
he never behaves in this way,
[211]
though I'm not so sure that's true.
[214]
Some people, however --
they are very future-oriented.
[218]
And most people -- they think
a little bit about the future
[222]
when making spending decisions.
[224]
So Ricardian equivalence
probably describes some people,
[228]
maybe not most people.
[231]
In any case, to the extent
[234]
that Ricardian equivalence
reflects how people plan,
[239]
tax cuts will be less effective
as fiscal stimulus
[243]
than they otherwise would be.
[246]
Okay, summing up.
[248]
Fiscal policy is complicated,
because it's not just a matter
[252]
of increasing
government spending --
[255]
we also have to take into account
how central banks, investors,
[261]
and consumers
respond to fiscal policy.
[265]
Moreover, how people respond
to fiscal policy isn't mechanical.
[271]
It depends upon their evaluation
of the economic situation
[276]
and their expectations
about the future.
[279]
So the same fiscal policy
can have different effects
[283]
in different historical situations.
[286]
Good economic policy
therefore requires
[289]
both an understanding
of the models
[291]
but also an understanding
and an appreciation
[295]
of the actual situation.
[298]
Thus, economic policy is
both science and art.
[303]
- [Narrator] You're on your way
to mastering economics.
[306]
Make sure this video sticks
by taking a few practice questions.
[309]
Or, if you're ready
for more macroeconomics,
[311]
click for the next video.
[315]
Still here?
[316]
Check out Marginal Revolution
University's other popular videos.
[319]
♪ [music] ♪
Most Recent Videos:
You can go back to the homepage right here: Homepage