Krugman Section 4

Modules 20 and 21

Fiscal Policy

Fiscal Policy

Fiscal policy is done by CONGRESS—not the Federal Reserve

Stabilization is done by G and Tax (T) collectionEverything equal, what puts more money in the

economy, G or a decrease in T?G! People can SAVE some of a tax break

The Employment Act of 1946Congress proclaimed gov’t role in promoting

max. employment, production and purchasing powerKeynesian Economics

Created the Council of Econ. Advisors to advise the President

Created the Joint Economic Committee of Congress to investigate econ. problems.

Discretionary Fiscal Policy

= changes to G or T are at the option of Congress

Two types = expansionary and contractionary

Expansionary PolicyUsed to combat recessionIncrease GDecrease TIf budget is balanced, a budget deficit is

createdGoal is to shift AD to the right

PL

GDPr

AD

SRAS

AD2

Y1

PL1

Y2

PL2

LRAS

Contractionary PolicyUsed to lower inflationA decrease in G An increase in TGoal is to shift AD to the left by taking

money out of the system

PL

GDPr

AD

SRAS

AD2

YI

PL1

Y2

PL2

LRAS

Financing Deficit Spending1. borrow from the public

Sell bonds to the public: take out loans

2. Money CreationFED loans money directly to the gov’tCould increase inflation

What to do with a Surplus

1. Pay off public debtBuy back bonds

Puts $ back into the system, increases consumption

• May offset contractionary policy that created the surplus

2. stand idleWithholds purchasing powerNo chance of inflation

Automatic Policy--Built In Stability

1. Income TaxAs income increases, people pay more taxes.

This limits the increase in DI and C.2. Unemployment compensation

The income of unemployed does not fall to zero. UC provides a base level of income.

3. Stocks and BondsDividends do not follow the swings of the

business cycle. Bond payments are established at the time the bond is purchased