• One major function of the government is tostabilize the economy (prevent unemploymentor inflation)

• Stabilization can be achieved in part bymanipulating the public budget-governmentspending and tax collections-to increaseoutput and employment or to reduceinflation.

• Congress reviews budget, enacts several.

• The President vetoes measures.

1. Balanced Budget

2. Surplus Budget

3. Deficit Budget

• What tools does the government have to regulate the economy?

• Who implements fiscal policy?

• TAXES

–Tax rates

• Income, corporate, excise, FICA

–Tax incentives

• GOV’T SPENDING

–Public goods, defense, social programs

1. Expansionary fiscal policy: used to combat arecession.

2. Contractionary fiscal policy: used to combatdemand-pull inflation, due to excessspending.

“What can government do?”

Expansionary Fiscal PolicyTo Reduce Unemployment…

a. Decrease taxes

b. Increase government spending

c. Combo of the two

Contractionary Fiscal PolicyTo Reduce Inflation…

a. Increase Taxes

b. Decrease Government Spending

c. Combo of the two

• Economist with a very different view from Adam Smith.

• Keynes said that the government SHOULD get involved in the economy

(to a limited extent.)

TAX INCENTIVES (CREDITS)Given to businesses and individuals to get them to do something the government wants them to do. (buy fuel-efficient cars, hire people

coming off of welfare.)

–During a slowdown of the economy

• INCREASE tax incentives

–During an inflationary period

• DECREASE tax incentives.

GOVERNMENT SPENDINGBuying all the things that government provides, from highways, to military, to education.

– During a slowdown of the economy

• INCREASE spending.

– During an inflationary period

• DECREASE spending.

• Shocks Originating from Abroad

• Net Export Effect