Unemployment and Fiscal Policy As recessions cause high unemployment, and too much Aggregate Demand can cause high inflation, as well as any other issue that may arise, congress can be prompted to act in order to promote full employment and stable price levels. Remember; congress has one job: To get re-elected!!!!! In order for this to work, people must work….. ….And prices must be stable enough for families to budget, and buy goods and services.

The United States’ GDP is not constant from year to year. Instead, the GDP grows most years and then shrinks in some years. The ups and downs in GDP over time is referred to as the business cycle.

Economic Recovery and the Peak: As the economy recovers and U ↓, consumers start to buy more goods and services. This is an increase in Demand, and causes Inflation, or the increase in average Price Levels (PL) of goods and services. Economic Recession and the Trough: As the economy worsens and U ↑, consumers stop buying goods and services. This is a decrease in Demand and Price Levels (PL) ↓.

The Business Cycle Peak Temporary maximum in Real GDP. At this point the unemployment rate (u%) is probably below the natural rate of unemployment, and the inflation rate (π%) is probably increasing. Recession The contractionary phase of the business cycle. A period of decline in Real GDP accompanied by an increase in u%. To be classified as a recession, the economic decline must be at least 6 months long. Trough The bottom of the business cycle. The u% is probably high and π% is probably low. Recovery The phase of the business cycle where the economy is returning to full employment.

The Business Cycle Causes Irregularity of Investment Changes in productivity Changes in total spending (aggregate demand) Durable goods manufacturing is most susceptible to the effects of the business cycle. Business cycle has become less severe because of technological advancements in supply-chain management and structural changes in U.S. economy.

Population Number of people in a country Labor force Number of people in a country that are classified as either employed or unemployed Labor Force Participation Rate % of population in the labor force (U.S. is approx 50%) Employed People 16 years and older that have a job. It doesn’t matter if it’s part-time or full-time, as long as they work at least 1 hour every 2 weeks. Unemployed People 16 years and older that don’t have a job, but have actively searched for a job in the last 2 weeks Unemployment rate = # of unemployed / # of people in labor force Not in Labor Force Kids, military personnel, retired people, stay at home Moms and Dads, full-time students, your 40 year old uncle who sleeps on the couch all day, most of the homeless, insane, incarcerated. Unemployment

Frictional “between jobs”, voluntary, good for individuals and society Structural Associated with lack of skills or declining industry (ex. High school dropouts, type-writer repairmen). Think “Creative Destruction” Cyclical Associated with downturns in business cycle. Bad for society and individuals. Seasonal Mall Santas, Schlitterbahn Life-guards, Ride operators at Fiesta Texas, Golf-pros in Alaska during January. 4 Types of Unemployment

Full Employment Occurs when there is no cyclical unemployment present in the economy Associate with the Natural Rate of Unemployment (NRU). 1.The level of unemployment experienced when the economy is producing at its full potential. 2.The United States’ NRU is approx. - 5% Associate Full Employment (FE) with the PPC, the long-run aggregate supply (LRAS) and the long-run Phillips curve (LRPC) THE IDEAL U% is 5%.

Fiscal Policy Government efforts to promote full employment and price stability by changing government spending (G) and/or taxes (T). John Maynard Keynes, a British economist, theorized using G and T to affect GDP and stabilize the economy by manipulating AD (Aggregate Demand). Recession is countered with expansionary policy. Increase government spending (G ) Decrease taxes (T ) Inflation is countered with contractionary policy Decrease government spending (G ) Increase Taxes (T )

Expansionary Fiscal Policy GDP R PL AD SRAS LRAS YFYF P Y AD 1 P1P1    If G ↑ or T ↓,then AD shifts → causing PL ↑ and GDP ↑,which causes u% ↓ Notice that the PL increased: this means expansionary fiscal policy creates some inflation. But Unemployment does go down. (More jobs = more votes!!!)

Expansionary Fiscal Policy Side-effect: ‘Crowding-out’ r% Q LF S LF D LF r q D LF 1 r1r1 q 1 r% II1I1 IGIG IDID As G↑ and T↓, the government must borrow money to cover the cost. This causes r% to increase, which makes it difficult for the private sector to justify taking out loans for expansion (Crowding them Out). If the private sector can’t get going on their own, then the government will expand to try and jump start the economy. This is how congress affects debt, when trying to reduce unemployment. (Remember: what is a politicians #1 job?)

GDP R PL AD SRAS LRAS YFYF P Y AD 1 P1P1    Contractionary Fiscal Policy IF INFLATION, THEN G↓ or T↑.: AD .: GDP R ↓ & PL↓.: u%↑ & π%↓ Notice: Unemployment goes up. Congress is unlikely to support contractionary policy. (This means they might risk getting re-elected!)

Keynes is probably the most influential economist since John Smith. His theories were applied during the Great Depression and are still relevant to today. Some of his influences include Automatic Stabilizers and Entitlements. Automatic Stabilizers: programs already approved by congress that automatically trigger in order protect the economy. Ex: food stamps, unemployment insurance, lower tax rates for the poor (think tax brackets). Entitlements: broad social programs that use eligibility requirements to provide income supplements. Ex: Social Security (triggers at a specified age) *In this case, social security acts as a “floor” for consumer purchasing power. This protects AD, and promotes a minimum level of consumption.

Supply Side Fiscal Policy Congress has tried to affect GDP by manipulating Aggregate Supply instead of Aggregate Demand. By lowering taxes and deregulation, or the removal of government restrictions on certain firms or industries, congress hoped to encourage companies to hire more employees and increase production, and thus GDP.

PL GDPr AS AD pl y Increase in Supply AS .: PL ↓ & GDPr ↑ AS 1 pl 1 yf 1 LRAS Supply-Side economics or “Reganomics” was popularized during the 1970’s, and focused on during the President Reagan administration of the 1980’s. Why? What was happening in the 1970’s? The thought behind these policies was that wealthy individuals and large businesses would spur economic growth. If nothing else, tax cuts mean that people would work harder they if knew they could keep more money. Do you think this is true? Do tax changes affect everyone the same way?

Laffer Curve – Lower Marginal tax rates will actually increase tax revenue. *This drove supply-side economics, and maximizing economic output. Criticism of Laffer Curve: It did not prove valid during the 1980’s under Reagan. a. Incentives of tax cuts caused limited impact. Some people work more, some less b. Inflation. Tax cuts near full-employment levels of output produce demand-pull inflation. Increases in AD overwhelm increases in AS. c. The optimal position on the curve is unknown.

The 6 years of economic growth and productivity (largest since WWII) that occurred in the 1980’s was caused by Paul Volcker, the Chairman of the Federal Reserve, fighting Stagflation of the 1970’s. President Reagan is often credited with the economic turn around, but his policies were either ineffective, or did not have the time necessary to take effect. President Reagan had the right idea as far understanding the economic issues at hand, but he did not have the right tools for the job. The Fed did.

The Multipliers and Circular Flow When congress uses fiscal policy to manipulate GDPr, their actions have a multiplied effect. Depending on how society/consumers are behaving, the multiple could be either large or small. This is a result of how these actions can affect Circular Flow, or how money flows through the economy from The Government, Businesses, and Households.

Product Market Factor Market Households GovernmentBusinesses / Firms >>$ taxes $>>> <<$ taxes $<< >>>factors of production>>> <<<public goods<<< >>>public goods>>> <<$ factor payments $<< <<<goods & services<<< >>$ government spending $>>

Government Spending/Investment Multiplier = 1 / (1 - MPC) Tax Multiplier = MPC / (1 – MPC) MPC = Marginal Propensity to Consume, or a consumer’s percentage of consumption for every additional dollar earned (like from a tax cut, or a pay raise). EXAMPLE; If MPC = 75% or.75 then: Gov’t Spending = 1 / (1 -.75) = 4 Tax Change =.75 / (1 -.75) = 3 If congress cuts taxes by $100Billion, then the effect on GDPr would be an increase of $300Billion. A tax cut would create economic growth, while a tax increase would hinder it. If congress increases spending by $100Billion, then GDPr would increase by $400Billion. An increase in spending would generate economic activity just like a tax cut would.

Economists use these multiplier to determine or estimate what affect fiscal policy will have on the GDPr and the economy. If there is a recession, 1. Should congress cut or raise taxes? 2. Should congress cut or raise spending? *What would be the effects on unemployment? *Would this be a popular choice for them? If there was inflation, 1.Should congress cut or raise taxes? 2.Should congress cut or raise spending? *What would be the effects on unemployment? *Would this be a popular choice for them? Once again: What is a politician’s #1 Job?