So, what is Fiscal Policy?

-The use of government spending and revenue collection to influence (the demand side of) the economy.

Chris is very excited to rock out with some fiscal

policy jams!!

So, it all begins with our Federal Budget. (See chart to the left, no your other left)

Basically, it’s the amount of money given to different areas of the government in a given fiscal year.

(Oct 1st – Sept. 30th)

It takes a really long time to prepare a budget (18 months) and all budget items must be passed by Congress as bills.

Yes, it’s all very interesting; budget, Medicare,

transmutation, what else is on?

(That’s “transportation” Peter)

OK, so why does it matter? What does Fiscal Policy do?

Fiscal Policy has to do with the idea that by changing government spending on programs and how much it taxes the people, it can stabilize the macroeconomy and affect output.

Please tell me these rogue economists remember that there are two kinds of Fiscal Policy… and Meg, shouldn’t you care more about how cool you aren’t?

The first kind is Expansionary Policy right? That’s where the

Government increases its spending on programs,

buys more stuff, and cuts peoples taxes so that the economy (GDP) will grow.

Yes Peter, more spending means more stuff which means prices go up (see

law of supply) and causes unemployment to drop. Less taxes means people have more money to

spend which forces Aggregate Demand to increase, ultimately

increasing output. (GDP)

No. Mr. Martinez, show them the graph.

Cool, so can I carry the big knife thing now?

The second type is called Contractionary Policy. It’s where the government

decreases spending and increases taxes in order to reduce the growth of the

economy (GDP).

I thought having a big and strong economy is a good thing? HOO-AH! U.S.A.! U.S.A.!

Yes, that’s all good and well until supply can’t meet

demand and producers raise prices which causes inflation Joe…you think that’s Hoo-Ah too? What about when your money won’t buy you protein

shakes huh?

Great, now that I understand Fiscal Policy and the President wants to cut taxes, I can sell Meg.

Jackpot.

You better stop right there pal! You know, Fiscal Policy is a great

tool, but there are some limits with its effectiveness.

THAT’S RIGHT!!

Difficulty in changing spending

levels due to entitlements

Predicting the future

Delayed results

Political Pressure and Coordination

All make Fiscal Policy really hard to use!! Yeah-

heah!!

So how does Fiscal Policy affect the average family??

Actually Peter, it all began with 2

economists, Adam Smith and John

Maynard KeynesSMITH KEYNES

Ready to Rumble? Let’s do this…

You see, Smith was a Classical Economist. He thought that if you leave things alone, the market would take care of itself. So we did, and we ended up in

a Great Depression.

But then came the first Keynesian Economist, John Maynard Keynes (go figure.) He argued that if we

want a solid market system, that we had to get involved down to the nitty gritty. Giggity goo!

Keynes said that if the government “jump-starts” the economy by spending

and cutting taxes so people will spend too, then we

would get out of the Depression. This is called

Demand-Side Economics.

One reason that Fiscal Policy is so powerful has to do with the Multiplier Effect. Basically, that every one dollar spent by the government becomes more than one dollar in the economy. For example, lets say the gov’t. invests 10 million dollars on

new goods. Those companies will now have 10 million dollars, but they will also use some of it to pay for workers’ salaries.

Company #1

Company #2

So that original $10 million investment turns into much more money for the

economy in the long run, and when all that money adds up…

The 6 million dollars (for salaries) will now be given to the workers who (like the gov’t and

Company #1) will go and spend some of their money on stuff from company #3, and so on…

The 8 million dollars (for salaries) will now be given to the workers who (like the gov’t) will go and spend some of their money on stuff from

company #2.

The other cool thing is that if set up right, Fiscal Policy’s stabilizers (as percentages) can be automatic so

we can have more DDR time!

Notice how, as time progresses, the government has been much

more adept at stabilizing the economy!

Awesome!