Chapter 5 Part 1 of World Economy. .pptx

World Economy Chapter 5 Part 1

1. Unit 5 (Part 1) – Government Spending, Taxation, and Multipliers Topics: Government Spending, Taxation, Multipliers Case Study: EU Austerity vs US Stimulus (2008–2012) Learning Objectives: • Define and explain government spending as a component of GDP. • Understand taxation structures and their economic impacts. • Evaluate the role of fiscal multipliers in recessions. • Compare EU austerity with US stimulus response during the Great Recession. • Draw lessons for modern fiscal policy and crisis management.

2. Government Spending – Definition • Government spending (G) = expenditure on goods and services by state. • Includes health, education, infrastructure, defense, and administration. • Excludes transfers (pensions, unemployment benefits). • Directly raises aggregate demand in GDP formula. • Size relative to GDP varies: higher in Europe (~40–50%) vs US (~35%). [Figure Placeholder: Insert Fig. 5.1 – Government spending share of GDP across countries].

3. Types of Government Spending • Current spending: wages, consumables, services. • Capital spending: infrastructure, R&D, investment. • Discretionary: varies by budget decisions. • Automatic stabilizers: unemployment insurance, progressive taxation. • Counter-cyclical role: expand in recessions, contract in booms.

4. Role of Government Spending • Stabilizes demand in downturns. • Provides public goods not efficiently supplied by markets. • Reduces inequality through welfare and services. • Influences long-term growth via infrastructure and education. • Criticism: risks inefficiency, crowding out, higher debt burdens.

5. Taxation – Introduction • Taxes finance government spending. • Progressive taxes: higher earners pay higher share (e.g., income tax). • Regressive taxes: flat rates (e.g., sales/VAT) burden lower incomes. • Corporate taxes, payroll taxes, capital gains also key. • Tax mix varies across OECD economies. [Figure Placeholder: Insert Fig. 5.5 – OECD tax structures comparison].

6. Economic Role of Taxes • Influence disposable income and consumption. • Affect incentives to work, save, and invest. • Redistribute income and reduce inequality. • Generate revenue for infrastructure and welfare. • Overly high taxes may discourage investment; overly low taxes weaken public services.

7. Fiscal Deficits and Debt • Deficit = spending exceeds revenue; financed by borrowing. • Public debt = accumulation of past deficits. • Keynesians: deficits acceptable in downturns. • Austerity view: deficits unsustainable, harm confidence. • Debate central in EU vs US 2008–2012 responses.

8. Fiscal Multipliers – Concept • Multiplier measures effect of government spending on GDP. • Formula: Multiplier = ΔGDP / ΔSpending. • Larger in recessions when unused capacity exists. • Smaller when economy at full employment. • Tax multipliers usually smaller than spending multipliers. [Figure Placeholder: Insert Fig. 5.10 – Fiscal multiplier illustration].

9. Determinants of Multipliers • Size depends on: – Marginal propensity to consume (MPC). – Openness of economy (imports leak demand). – Exchange rate flexibility. – Debt sustainability perceptions. • Higher in closed economies with slack demand.

10. Spending vs Tax Multipliers • Spending multipliers > tax multipliers. • Direct spending injects demand immediately. • Tax cuts rely on consumer response. • Example: IMF estimated US fiscal multiplier 1.5+ in 2009. • EU austerity multipliers underestimated initially.

11. Case Study – US Stimulus 2008–2012 • American Recovery and Reinvestment Act (ARRA) 2009: ~$831 billion. • Mix of spending, tax cuts, transfers. • Focus on infrastructure, clean energy, social safety nets. • US GDP recovered by 2010–11, unemployment declined. • Fiscal stimulus sustained demand during crisis. [Figure Placeholder: Insert Fig. 5.14 – US GDP Growth 2008–2012].

12. Case Study – EU Austerity 2008–2012 • EU response: fiscal tightening in Greece, Spain, Portugal, UK. • Spending cuts and tax hikes to reduce deficits. • GDP contracted, unemployment soared. • IMF later admitted multipliers underestimated. • Led to double-dip recession in Eurozone. [Figure Placeholder: Insert Fig. 5.15 – EU GDP and unemployment 2008–2012].

13. Comparing US and EU Responses • US stimulus supported recovery. • EU austerity deepened recession. • Fiscal multipliers higher in downturn than assumed. • Confidence effects from austerity outweighed by demand collapse. • Highlighted importance of timely fiscal support.

14. Impact on Unemployment • US unemployment peaked ~10% in 2009, fell steadily after. • EU unemployment remained high, especially youth unemployment in Spain/Italy >40%. • Recovery gap widened between US and Europe. • Highlighted costs of premature austerity.

15. Debt Sustainability Debate • EU insisted austerity necessary to restore confidence in bond markets. • US prioritized recovery over immediate debt concerns. • Yields on US debt remained low despite deficits. • EU periphery faced debt crises (Greece, Portugal, Ireland). • IMF revised stance, recognizing role of multipliers.

16. Automatic Stabilizers • Unemployment insurance cushions income in recessions. • Progressive taxation stabilizes demand. • Stronger in US than EU periphery. • Automatic stabilizers reduce need for discretionary stimulus. • Still, discretionary policies essential during 2008–09 crisis.

17. Lessons from US Stimulus • Fiscal expansion prevented deeper recession. • Infrastructure and transfers had large multipliers. • Early action critical to recovery. • Stronger automatic stabilizers would have reduced need for emergency measures.

18. Lessons from EU Austerity • Premature tightening deepened downturn. • Fiscal multipliers underestimated. • Social costs of austerity severe: inequality, poverty. • Highlighted weakness of Eurozone institutions (no joint fiscal capacity). • Case for fiscal union in EU strengthened.

19. Policy Lessons Overall • Fiscal multipliers context-dependent. • Expansion more effective during recessions. • Austerity less effective when economies depressed. • Balanced approach needed: stimulus in crisis, consolidation in recovery. • Importance of credible, coordinated policies.

20. Relevance Today • COVID-19: governments used large stimulus packages globally. • US $1.9 trillion American Rescue Plan (2021). • EU suspended austerity rules, launched €750bn recovery fund. • Fiscal multipliers again central to debates. • Inflation surge 2022 revived debt sustainability concerns.

21. Criticisms of Fiscal Policy • Risks of crowding out private investment. • Higher debt burdens future taxpayers. • Potential inflationary effects. • Implementation lags reduce effectiveness. • Despite criticisms, evidence supports stimulus in recessions.

22. Alternative Perspectives • Modern Monetary Theory (MMT): governments with sovereign currency can sustain higher deficits. • Critics argue MMT risks inflation. • Austerity advocates stress credibility. • Debate continues over role of fiscal rules (e.g., EU Stability Pact).

23. Case Study Conclusion • US stimulus vs EU austerity demonstrates contrasting outcomes. • Fiscal multipliers larger in recessions than assumed. • Policy timing and credibility critical. • Lessons influenced responses to COVID-19 and current crises.

24. Summary of Key Points • Government spending and taxation shape aggregate demand. • Fiscal multipliers amplify impact of policies. • US stimulus accelerated recovery, EU austerity delayed it. • Modern crises confirm fiscal policy’s central role. • Future debates focus on balancing growth, inequality, and debt.

25. Next Steps – Unit 5 Part 2 • Focus shifts to central banks, inflation targeting, and interest rates. • Case Study: US Fed vs ECB monetary policy approaches.