Today’s Warm Up

• Turn to page 396 and read the section, “A New Role for Government”

• In your notes, define Keynesian Economics and be ready to share!

Fiscal PolicyToday’s LEQ: How are monetary and fiscal policy used to achieve economic stability?

The Employment Act of 1946

• “The Congress hereby declares that it is the continuing policy of the Federal Government to use all practicable means… to promote maximum employment, production, and purchasing power.”

• Answer in your notes: How does the Employment Act of 1946 relate to Keynesian Economics?

Activity 1: U.S. Unemployment Rates & the Federal Budget, 1928-1946

• Using the data on unemployment over this period and your general knowledge of history and economics, answer the discussion questions.

Be ready to share!

What is Fiscal Policy?

• The use of government spending and revenue collection to influence the economy–Specifically, to promote economic

growth, full employment, and price stability

• Every year, the gov’t decides how much to spend and how much to tax

Expansionary Fiscal Policy

• Used to encourage growth when the economy is in recession or to prevent a recession• Falls into either one or both

categories: increase gov’t spending and cutting taxes

Increase in Gov’t Spending

Increases aggregate demand & causes prices

to rise

Higher prices encourage suppliers of g/s to

produce more

Firms hire more workers leading to lower

unemployment and increase in output – the

economy EXPANDS!

Cutting Taxes

Individuals have more money to spend and

businesses keep more of their profits.

Consumers spend more on g/s and firms have

more money to spend on land, labor, and capital.

These actions will increase demand, prices,

and output – the economy EXPANDS!

Expa

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Fis

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Polic

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Contractionary Fiscal Policy

• Used to decrease growth – For example, when fast-growing demand exceeds

supply, producers must choose – raise prices or raise output

– Often leads to high inflation discouraging economic growth and stability

• Falls into one or both of two categories: decrease gov’t spending and raising taxes

Cont

racti

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y Fi

scal

Pol

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Decreasing Gov’t Spending

Decreases aggregate demand b/c the gov’t is buying less than before.

Lower prices encourage suppliers to cut their

production and possibly let workers go.

Lower production lowers the growth rate -

the economy CONTRACTS!

Increasing Taxes

Individuals have less money to spend and

businesses keep less of their profits.

Consumers spend less on g/s and firms have

less money to spend on land, labor, and capital.

These actions will decrease demand,

prices, and output – the economy CONTRACTS!

Activity 2: Expansionary or Contractionary Fiscal Policies? That is the Question!

• In the situations provided, decide whether the appropriate fiscal policy response is expansionary (E), contractionary (C), or no change (NC). Write E, C, or NC next to each statement to indicate the policy you believe is most appropriate.

Limits to Fiscal Policy

• Political Pressures: Candidates may not always have the courage to do the right thing when its unpopular with voters

Go back to Activity 2…

• Based on the situations provided, could candidates win a national election by supporting Keynesian discretionary policies?

• Go through each situation and decide yay or nay and why

Limits to Fiscal Policy

• Time Lags: Congress and the President also have to know when to implement fiscal policies – Fiscal policy takes time!– Recognition Lag– Administrative Lag– Operational Lag

Think of a red light… Create your own analogy…

Limits to Fiscal Policy

• Predicting the Future: It’s difficult to know current state of the economy. Business cycle is unpredictable & politicians may put off making changes in fiscal policy until more info is available. By then it’s often too late

Think of the idiot in the shower…Create your own analogy…

Complete After Your Quiz:Limits to Fiscal Policy

• Use pages 391 – 393 to fill out the rest of the “limits to fiscal policy” chart on the back of your guided notes.

Be ready to share!

Automatic Stabilizers• Not all fiscal policies are discretionary – some

are set up to stabilize the economy automatically

• Discretionary fiscal policies involve a deliberate decision by the Prez/Congress to manipulate taxes/spending to stabilize the economy

• Most taxes and transfer payments (i.e. social security, welfare, unemployment compensation) are tied to GDP and personal income, so they change automatically

Examples of Automatic Stabilizers

• Higher unemployment (contractionary phase) higher spending for unemployment compensation & revenues from income taxes automatically fall (automatic expansionary stabilizer)

• Higher inflation (expansionary phase) wages and price levels rise & gov’t receives more income and sales taxes (automatic contractionary stabilizer)

The US experienced strong economic swings before WWII. Why did this change?

Automatic Stabilizers• After WWII, federal taxes and

transfer payments sharply increased• Both helped stabilize economic

growth

Activity 3: Automatic Stabilizers

• Identify which of the policies listed there are automatic fiscal stabilization policies

Activity 4: Memorandum from the President of the United States

• Take on the role of the Council of Economic Advisors (CEA) and prepare a report for President Wynn on appropriate fiscal policy actions, based on the economic data provided in the handout.

Be ready to read your report to the class!