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Macro Economics: Tax Reduction Add in library

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Question:

Describe about the  Macro Economics for Tax Reduction?
 
 

Answer:

Tax reduction by the government is a form of ‘expansionary fiscal policy’. With tax cut by the government, consumers have more disposable income. This means less money paid to the tax authority i.e. more money in the pockets of consumers, leading to increased spending and less saving. The output equation becomes:

Y=C(Y-T) +I+G+NX

Where, Y=Output, C=Consumption spending, I=Investment spending, G= Govt. spending, NX=Net exports, T=Tax.

Tax cut evokes positive shocks to aggregate demand. The long-run aggregate supply curve shifts outward because the natural rate of output rises. This spending results in greater supply, which means suppliers need to hire more employees or pay overtime and higher wages to existing ones to motivate them to produce more. This in turn creates new jobs and higher wages and yet higher total disposable income in the economy, further increasing aggregate demand.

Short-run analysis:

In the short run, there will be an outward shift of the aggregate demand curve. The real income and price will increase. It shifts the long-run aggregate supply curve outward because the natural rate of output rises. Short run aggregate supply is unchanged.

Lon-run analysis:

Lon-run analysis

Tax cuts, in the long run, will shift aggregate supply to the right. Prices will fall. Truth is tax cut produces a very small increase in aggregate supply & relatively large increase in aggregate demand. In long period, output is essentially determined by aggregate supply & price by the movement of aggregate demand relative to the movement of aggregate supply. In the long run, shifts in aggregate demand affect the overall price level but do not affect output.

 

Fisherian equation states,

Real interest rate (r) =Nominal interest rate (n) –Expected inflation rate (i)

Thus,  

Or, n= (5/100) + (8/100)

Or, n= (5+8)/100

Or, n =13/100

Therefore, required n=0.13                                 

"Stagflation” means ‘stagflation’ plus ‘inflation’. It is a sustained period of both high inflation leading to high price rise and unemployment leading to slow economic growth. We now interpret this as resulting from price shocks, which affect aggregate supply. 

A three week lag was there between Federal Reserve policy meeting and the minutes release of that meeting. No, there was no consensus by officials on raising short-term interest rates in June as several officials thought June would be the right time to raise rates, others thought it would be better to wait longer and some thought the Fed might need to wait until 2016. Fed would raise rates when there would be further improvement in the labor market & inflation would rise to 2% target. They would temporarily remove the imposed cap on new instruments known as ‘overnight reverse repos’. It could be too early to raise the rates, failing which would need to reverse course on rates. Exports could fall down due to appreciation of dollar.

Three reasons why Fed could delay raising rates in June are:

Ø  Anticipating improvement in labor market& inflation to rise to 2% target.Ø  Raising rates too much too soon could weaken the economy & could then be forced to reverse course on rates.Ø  Appreciation of dollar would mean restrain in US net exports.Two reasons not to delay are:Ø  To move up away from zero floorØ  Dollar rose to 20% in the past years. The increase has already had some of the effects on the economy that higher interest rates would produce, including slowing growth and lower inflation.

FED increases interest rates mainly to combat inflation (i.e. bring price stability) & to avoid too much growth (i.e. to reach a level of sustainable economic growth.).  Higher rates mean less disposable income for consumers. So, Savings goes up & spending goes down.  As inflation rises, consumers & producers will cut back on spending. Prices go up when demand is greater than supply. This leads to fall in demand. This means the producers would cut down their production due to less demand. Less production means number of workers will be reduced by the producer leading to unemployment.

 

Factors leading to recession are:

drop in real wages; sharp decline in retail, devaluation. The external causes leading to recession in Russia are, fall in world oil prices and western sanctions imposed on Russia are the external causes.

Brisk action not taken by the central bank in taking action against persistent falling ruble.

One Monetary policy action is “lowering rates.

One Fiscal policy action is increasing govt. spending.”

The practical problems with the implementation of monetary policy is that “saving will be discouraged. Thus, savers see a decline in income because they receive lower income payments.”

The practical problem with the implementation of fiscal policy is that “it is at the expense of private sector spending and is therefore potentially harmful to some firms.”

OR

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