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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