Problems With Fiscal Policy

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Problems With Fiscal Policy•When there is a recessionary gap what two options does Congress have to fix it?•What’s wrong with combining both?

Deficit Spending!!!!•A Budget Deficit is when the government’s expenditures exceeds its revenue. •The National Debt is the accumulation of all the budget deficits over time. •If the Government increases spending without increasing taxes they will increase the annual deficit and the national debt.

Most economists agree that budget deficits are a necessary evil because forcing a balanced budget would

not allow Congress to stimulate the economy. 2

Explain this cartoon

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Who ultimately pays for excessive government spending?

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Additional Problems with Fiscal Policy1. Problems of Timing

• Recognition Lag- Congress must react to economic indicators before it’s too late

• Administrative Lag- Congress takes time to pass legislation

• Operational Lag- Spending/planning takes time to organize and execute ( changing taxing is quicker)

2. Politically Motivated Policies• Politicians may use economically inappropriate

policies to get reelected. • Ex: A senator promises more welfare and public

works programs when there is already an inflationary gap.

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3. Crowding-Out Effect• In basketball, what is “Boxing Out”?• Government spending might cause unintended

effects that weaken the impact of the policy.Example:• We have a recessionary gap• Government creates new public library. (AD increases)• Now but consumer spend less on books (AD decreases)Another Example:• The government increases spending but must borrow

the money (AD increases) • This increases the price for money (the interest rate).• Interest rates rise so Investment to fall. (AD decrease)

The government “crowds out” consumers and/or investors 9

Additional Problems with Fiscal Policy

4. Net Export EffectInternational trade reduces the effectiveness

of fiscal policies. Example:

• We have a recessionary gap so the government spends to increase AD.

• The increase in AD causes an increase in price level and interest rates.

• U.S. goods are now more expensive and the US dollar appreciates…

• Foreign countries buy less. (Exports fall)• Net Exports (Exports-Imports) falls, decreasing AD.

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Additional Problems with Fiscal Policy

Explain this cartoon

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Activity

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Congressional CommitteesAs a group, analyze the situation, identify the

problem, and identify your solution

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Unemployment Inflation GDP Growth

Good 6% or less 1%-4% 2.5%-5%

Worry 6.5%-8% 5%-8% 1%-2%

Bad 8.5 % or more 9% or more .5% or less

The Good, the Bad, and the Ugly

1.) 1933Situation:• GDP fell -1.2%• Inflation rate= -.5%• Unemployment Rate=25%Your Solution:What actually happened:• FDR increased public works via the New

Deal programs.

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2.) 1944Situation:• GDP grew 8%• Inflation rate= 3.7%• Unemployment Rate=1.2%Your Solution: What actually happened: • War ended the next year and government

orders for war materials decreased.• Many public works programs were

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3.) 1980Situation:• GDP fell -0.3%• Inflation rate= 13.5%• Unemployment Rate=7.1%Your Solution: What actually happened:• The next year, President Regan and congress

lowered taxes on individuals and corporations by about 30%. (Supply-side Economics)

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4.) 2003Situation:• GDP fell 0.5%• Inflation rate= 1.5%• Unemployment Rate=12.0%Your Solution:What actually happened:• Congress voted to give tax cuts to citizens.

(Bush Tax Cuts)

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