Price level Real GDP (billions) Draw and Practice AD 1 AD P2P2 $50FE $100 AS 1.What type of gap? 2.Contractionary or Expansionary needed? 3.What are two options to fix the gap? 4.How much needed to close gap? LRAS Congress uses discretionary fiscal policy to the manipulate the following economy (MPC =.9) -$5 Billion 1 Copyright ACDC Leadership 2015

Price level Real GDP (billions) Draw and Practice 1.What type of gap? 2.Contractionary or Expansionary needed? 3.What are two options to fix the gap? 4.How much initial government spending is needed to close gap? AD 2 AD 1 +$40 Billion Congress uses discretionary fiscal policy to the manipulate the following economy (MPC =.8) P1P1 $800 $1000FE AS LRAS 2 Copyright ACDC Leadership 2015

Problems With Fiscal Policy 3 Copyright ACDC Leadership 2015

5 Problems With Fiscal Policy When there is a recessionary gap what two options does Congress have to fix it? What’s wrong with combining both? 1. Deficit Spending!!!! A Budget Deficit is when the government’s expenditures exceeds its revenue. The National Debt is the accumulation of all the budget deficits over time. If the Government increases spending without increasing taxes they will increase the annual deficit and the national debt. Most economists agree that budget deficits are a necessary evil because forcing a balanced budget would not allow Congress to stimulate the economy. 4 Copyright ACDC Leadership 2015

US National Debt 5 US Debt Clock Copyright ACDC Leadership 2015

The Onion: Government Stages Coup 6 Copyright ACDC Leadership 2015

30-7 Federal Budget Balance Actual and Projected, Fiscal Source: Congressional Budget Office $ Budget Deficit (-) or Surplus, Billions ActualProjected(as of March 2008)

Current Budget Projections 30-8

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30-11

Debt as Percentage of GDP 30-12

Who owns the debt? 30-13

14

Foreign Ownership of Debt 30-15

30-16

30-17

30-18

` 30-19

5 Problems with Fiscal Policy 2. Problems of Timing Recognition Lag- Congress must react to economic indicators before it’s too late Administrative Lag- Congress takes time to pass legislation Operational Lag- Spending/planning takes time to organize and execute ( changing taxing is quicker) 3. Politically Motivated Policies Politicians may use economically inappropriate policies to get reelected. Ex: A senator promises more welfare and public works programs when there is already an inflationary gap. 20 Copyright ACDC Leadership 2015

4. Crowding-Out Effect In basketball, what is “Boxing Out”? Government spending might cause unintended effects that weaken the impact of the policy. Example: We have a recessionary gap Government creates new public library. (AD increases) Now but consumer spend less on books (AD decreases) Another Example: The government increases spending but must borrow the money (AD increases) This increases the price for money (the interest rate). Interest rates rise so Investment to fall. (AD decrease) The government “crowds out” consumers and/or investors 21 5 Problems with Fiscal Policy Copyright ACDC Leadership 2015

5. Net Export Effect International trade reduces the effectiveness of fiscal policies. Example: We have a recessionary gap so the government spends to increase AD. The increase in AD causes an increase in price level and interest rates. U.S. goods are now more expensive and the US dollar appreciates… Foreign countries buy less. (Exports fall) Net Exports (Exports-Imports) falls, decreasing AD Problems with Fiscal Policy Copyright ACDC Leadership 2015

1.Aggregate Demand 2.Real Balance Effect 3.Interest Rate Effect 4.Foreign Trade Effect 5.Shifters of AD (C,I,G,X) 6.Aggregate Supply 7.Shifter of AS (R.A.P.) 8.Short Run AS 9.Long Run AS 10.Two Types of Inflation 11.Ratchet Effect 12.Classic vs. Keynesian 13.Three Ranges of AS List the 25 Concepts we have covered 14. Fiscal Policy 15. Discretionary vs. Non- Discretionary 16. Expansionary Policy 17. Contractionary Policy 18. The Car Analogy 19. Multiplier Effect 20. Calculating the Spending Multiplier 21. MPC and MPS 22. Deficit Spending 23. Timing Problems 24. Crowding-Out Effect 25. Net Exports Effect 23