Chapter 15

Using Fiscal Policy

Fiscal Policy is the federal government’s use of taxes

and government spending to affect the economy. There are three primary types:

Expansionary Fiscal Policy is a plan to increase aggregate demand and stimulate the economy.

Contractionary Fiscal Policy is a plan to reduce aggregate demand and slow the economy.

Discretionary Fiscal Policy refers to actions selected by the government to stabilize the economy.

Fiscal Policy

There are a few tools used

frequently by the government to quickly stabilize the economy (automatic stabilizers). 1. Public Transfer Payments

(the more the pay, the less they have to spend)

2. Progressive Income Taxes (Income tax)

Overall Goal = Stability

Used to increase Aggregate

Demand. Causes prices to rise. Provides incentives to

businesses in order to increase GDP.

There is a decrease in unemployment, increase in government spending, and/or a decrease in taxes.

Expansionary Fiscal Policy

Used to reduce inflation or

when the economy is growing too rapidly.

Decrease in government spending and an increase in taxes in order to control inflation.

Creates a trickle down effect where people have less money to spend so they do not over buy items.

Contractionary Fiscal Policy

#1 Policy Lags: Congress can take longer than

needed to act. #2 Timing Issues: It has to match up with the

business cycle. #3 Rational Expectations Theory: This accounts

for people acting ahead of time because they predict coming changes.

#4 Political Issues: Often times leaders act to get reelected not always to provide the best answer.

#5 Regional Issues: Not all parts of a country may face the same economic issues.

Limitations of Fiscal Policy

Demand-Side and Supply-Side Policies

Developed from the ideas of

economist John Maynard Keynes who believed economic issues should be solved with government action.

The focus is to increase aggregate demand as a way of improving the economy.

Demand-Side Economics

Keynes believed that changes in

demand influenced the business cycle. He focused on investment as the key

out of the GDP equation. By increasing investment, Keynes

believed that there would be a spending multiplier effect where a small change would have a great impact.

Keynesian Theory

With Demand-Side Fiscal Policy, the

government must make choices to increase demand and control inflation.

Keynes proposed a highly active government that used and expansionary policy to seek full employment.

The downside is although this works for recovery, it is hard to slow down after the recovery.

Government and the Demand-Side

The goal of supply-side

policies is to provide incentives to producers to increase aggregate supply.

Supply-Side economics favors less government involvement in the areas of taxation, spending, and regulation.

Supply-Side Economics

The Laffer Curve is a

graph that illustrates the economist Arthur Laffer’s theory of how tax cuts affect tax revenues.

The idea is that when taxes go beyond a certain point, revenue decreases because people lose the incentive to work.

The Laffer Curve and its’ Effects

Deficits and the National Debt

A budget surplus is when the government

takes in more revenue tan it spends and budget deficit is the opposite.

Deficit Spending is the government practice of spending more money than it takes in a given year. The growing annual deficits add up to the national debt.

http://www.usdebtclock.org/

Federal Deficit and Debt

#1 National Emergencies #2 Need for Public Goods and Services (ex.

Infrastructure) #3 Stabilization of the Economy: Government

Programs and Bail Outs #4 Role of Government in Society (ex. Social

Security)

Causes of Deficit

When the government

does not receive enough revenue it can borrow in 3 forms. #1 Treasury bills mature in

less than 1 year #2 Treasury notes mature

between 2 and 10 years #3 Treasury bonds mature

in 30 years

Money for Deficit Spending

One major effect

is the crowding out effect where the government owns more in bonds than private owners do.

Effect of the Debt on the Economy