fISCAL pOLICY MULTIPLIER eFFECT

Crowding In (LIBERAL) or Crowding Out (CONSERVATIVE)?

Crowding Out compromise:

DEPENDS ON WHERE YOU START.

cROWDING IN AT b AND cROWDING OUT AT a

SPRING 2011

GAME OVER

Keynesian Macro Model

LOGICAL pATH VERSION

KEYNESIAN MACRO MODEL

ALGEBRAIC VERSION

3. INCOME/AGGREGATE DEMAND IDENTITY

Y = AD

ONE PERSON'S SPENDING IS ANOTHER PERSON'S INCOME

kEYNESIAN

MULTIPLIER Example:

If b = .8 then a = 1/(1-B) = 1/.2 = 5

AND DY = 5 DI OR 5 DG

SO IF DI OR DG = $100M, THEN DY = $500M

because DI OR DG spins off DC = $400M

("CROWDING IN")

CONSERVATIVE view

IF Dy = aDg and

Dy = 0 at full employment Max y*

then a = 0 for any Dg > 0

Dg > 0 CAUSES inflation which

reduces Dc < 0 AND/OR Di < 0.

Public Spending crowds out Private

and Fiscal Policy IS zERO-SUM

(Crowding Out)

Crowding Out compromise:

fISCAL pOLICY MULTIPLIER eFFECT

DEPENDS ON WHERE YOU START.

cROWDING IN AT b AND cROWDING OUT AT a

FISCAL POLICY TOOL BOX

BASIC multiplier a = 1 / (1 - b)

Example:

If b = .8 then a = 5 and -ab = -4

(tip: tax multiplier -ab IS ALWAYS 1-a,

regardless value of b )

SPECIAL CASE DG = DT

Balanced Budget Multiplier

Dy = a Dg - abDt

IF DG = DT, then Dy = a Dg - abDG

Dy = a(1-b)Dg = (1-b)/(1-b) Dg

so Dy = Dg= Dt ,

regardless of value of b

Classical Macro Model

(CONSERVATIVE) LOGICAL VERSION

CLOSING THE BACK DOOR

("Internal" Rate of Return)

keynesian investment decision

INTEREST		BUSINESS		AGGREGATE
RATEs		INVESTMENT		DEMAND

INTERNAL RATE OF RETURN

IRR = CF/ K

investment RULE:

Compare IRR to Market Rate R

if IRR > r, then DO it .

internal rate of return

THE HOUSING CYCLE

© 2010 Vanderbilt