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Chapter: Monetary and fiscal policy in a closed economy

The budget deficit equivalent to total government spending tax minus total government spending revenue.If income tax independently, but depend on the net income, | Chapter 25 Monetary and fiscal policy in a closed economy David Begg, Stanley Fischer and Rudiger Dornbusch, Economics, 6th Edition, McGraw-Hill, 2000 Power Point presentation by Peter Smith Bringing together the real and financial sectors Having seen equilibrium in the goods and money markets separately, it is now time to explore the links between them and to look at simultaneous equilibrium in both. 25. Consumption revisited Income is a key determinant of consumption but other factors shift the consumption function household wealth availability of credit cost of credit These create a link between the financial and real sectors because interest rates can be seen to influence consumption. 25. See Section 25-1 in the main text. The permanent income hypothesis A modern theory of consumption developed by Milton Friedman argues that people like to smooth planned consumption even if income fluctuates Consumption depends upon permanent not transitory income. 25. See Section 25-1 | Chapter 25 Monetary and fiscal policy in a closed economy David Begg, Stanley Fischer and Rudiger Dornbusch, Economics, 6th Edition, McGraw-Hill, 2000 Power Point presentation by Peter Smith Bringing together the real and financial sectors Having seen equilibrium in the goods and money markets separately, it is now time to explore the links between them and to look at simultaneous equilibrium in both. 25. Consumption revisited Income is a key determinant of consumption but other factors shift the consumption function household wealth availability of credit cost of credit These create a link between the financial and real sectors because interest rates can be seen to influence consumption. 25. See Section 25-1 in the main text. The permanent income hypothesis A modern theory of consumption developed by Milton Friedman argues that people like to smooth planned consumption even if income fluctuates Consumption depends upon permanent not transitory income. 25. See Section 25-1 in the main text. Savings occur during middle age and dissaving in youth and old age. The life-cycle hypothesis A theory of consumption developed by Ando and Modigliani. Age 0 Income, consumption Death Individuals try to smooth their consumption, based on expected lifetime income. Permanent income Thus wealth and interest rates may influence consumption. Income varies over an individual's lifetime. Actual income 25. See Section 25-1 in the main text. Ricardian equivalence Individuals will react to a shock such as a tax change in different ways, depending on whether changes are seen to be temporary or permanent. If the government cut taxes today, but individuals realise this will have to be balanced by higher taxes in the future, then present consumption may not adjust. 25. See the "Economics in action" box in the main text. Investment demand Investment spending includes: fixed capital Transport equipment Machinery & other equipment Dwellings Other buildings Intangibles working