Fiscal Policy Chapter 15

Understanding Fiscal Policy Chapter 15, Section 1

Fiscal Policy Fiscal policy is the use of government spending and revenue collection to influence the economy Fiscal policy is the use of government spending and revenue collection to influence the economy Federal Budget…plan for the reception and spending of government revenues Federal Budget…plan for the reception and spending of government revenues Plan indicates what the fed. gov’t has in expenses Plan indicates what the fed. gov’t has in expenses Takes 18 months to prepare Takes 18 months to prepare Fiscal year…12 month period that begins on any date (Gov’t uses Oct. 1 – Sept. 30) Fiscal year…12 month period that begins on any date (Gov’t uses Oct. 1 – Sept. 30)

Actions of Fiscal Policy Expansionary policy Expansionary policy Fiscal policy that encourages economic growth (used to prevent recession) Fiscal policy that encourages economic growth (used to prevent recession) Higher spending by the gov’t, tax cuts Higher spending by the gov’t, tax cuts Gov’t buys more goods & services to create jobs Gov’t buys more goods & services to create jobs Contractionary Policy Contractionary Policy Fiscal policy that reduces economic growth Fiscal policy that reduces economic growth Lower gov’t spending, higher taxes (decrease demand) Lower gov’t spending, higher taxes (decrease demand) Gov’t buys less goods to slow GDP growth Gov’t buys less goods to slow GDP growth

Limits of Fiscal Policy Hard for the government to change spending levels Hard for the government to change spending levels Spending comes from disposable income Spending comes from disposable income Hard to predict the future Hard to predict the future Sometimes gov’t action is too late so they may wait until they KNOW more information Sometimes gov’t action is too late so they may wait until they KNOW more information Delayed time…changes don’t happen overnight (budget planning takes 1.5 yrs) Delayed time…changes don’t happen overnight (budget planning takes 1.5 yrs) Economy may be moving in different direction Economy may be moving in different direction

Review 1. Fiscal policy is (a) the federal government’s use of taxing and spending to keep the economy stable. (b) the federal government’s use of taxing and spending to make the economy unstable. (c) a plan by the government to spend its revenues. (d) a check by Congress over the President. 2. Two types of expansionary policies are (a) raising taxes and increasing government spending. (b) raising taxes and decreasing government spending. (c) cutting taxes and decreasing government spending. (d) cutting taxes and increasing government spending.

Fiscal Policy Options Chapter 15, Section 2

Fiscal Policy Options Classical Economics…the idea that the free market regulates itself Classical Economics…the idea that the free market regulates itself Great Depression proved this incorrect Great Depression proved this incorrect Demand should have increased during GD bec of falling prices but did not Demand should have increased during GD bec of falling prices but did not Keynesian Economics Keynesian Economics The idea that the gov’t should increase spending to spark demand and help the economy The idea that the gov’t should increase spending to spark demand and help the economy Know as demand side economics Know as demand side economics

Demand Side Economics Results in the multiplier effect Results in the multiplier effect Idea that $1 spending by the government results in many more in the private sector Idea that $1 spending by the government results in many more in the private sector Fiscal policy carried out is multiplied Fiscal policy carried out is multiplied Automatic Stabilizers (taxes) Automatic Stabilizers (taxes) If set up properly, fiscal policy can automatically stabilize the economy If set up properly, fiscal policy can automatically stabilize the economy Low income…lower taxes and more transfer payments for people. Gov’t takes less, you spend $ Low income…lower taxes and more transfer payments for people. Gov’t takes less, you spend $ High income…more taxes and fewer transfer payments. Gov’t take more, you save $ High income…more taxes and fewer transfer payments. Gov’t take more, you save $

Supply Side Economics Belief that the economy should work to increase supply: aggregate supply goes up Belief that the economy should work to increase supply: aggregate supply goes up Too much government control will reduce productivity (Ex. Taxes that are too high) Too much government control will reduce productivity (Ex. Taxes that are too high) Taxes that are too high will discourage work Taxes that are too high will discourage work Calls for less government spending and tax cuts Calls for less government spending and tax cuts Tax cuts increase employment so much so that the gov’t actually collects more $$ at a new, low rate Tax cuts increase employment so much so that the gov’t actually collects more $$ at a new, low rate

Review 1. What are the two main economic problems that Keynesian economics seeks to address? (a) business and personal taxes (b) military and other defense spending (c) periods of recession or depression and inflation (d) foreign aid and domestic spending 2. Government taxes or spending categories that change in response to changes in GDP or income are called (a) fiscal policy. (b) automatic stabilizers. (c) income equalizers. (d) expansionary aids.

Budget Deficits and the National Debt Chapter 15, Section 3

Deficits and National Debts The federal budget is rarely balanced The federal budget is rarely balanced Either running a surplus (more $ coming in) or a deficit (more $ going out) Either running a surplus (more $ coming in) or a deficit (more $ going out) Two ways to combat the deficit Two ways to combat the deficit Create money (increase $$ in circulation) Create money (increase $$ in circulation) May lead to hyperinflation (prices/goods increase) May lead to hyperinflation (prices/goods increase) Borrow money Borrow money Sell bonds for project (highways, roads, etc.) Sell bonds for project (highways, roads, etc.) Borrowing increases the debt Borrowing increases the debt

Problems with the National Debt Borrowing money creates a national debt Borrowing money creates a national debt Debt is not the same as deficit Debt is not the same as deficit Nat’l debt is all the $ the gov’t owes creditors Nat’l debt is all the $ the gov’t owes creditors Problems arise with the national debt Problems arise with the national debt Crowding out effect Crowding out effect Creates investment competition for private business (gov’t crowds out private borrowing) Creates investment competition for private business (gov’t crowds out private borrowing) Servicing the debt Servicing the debt Paying off interest on the debt is an opportunity cost bec the $ could be spent on something else Paying off interest on the debt is an opportunity cost bec the $ could be spent on something else

Review 1. A balanced budget is (a) a budget in which expenditures equal revenues. (b) a budget in which expenditures do not equal revenues. (c) a budget in which the government spends money. (d) a budget in which revenues equal taxes. 2. Which of the following are problems associated with a national debt? (a) increased spending on defense and education (b) the crowding-out effect and interest payments on the debt (c) interest payments on the debt and too much individual investment (d) increased individual investment and decreased government spending