Chapter 12 “Fiscal Policy”

Fiscal policy Changes in taxes and government spending designed to affect Aggregate Demand.

Keynesian Economics The idea that government fiscal actions can stabilize the economy gained acceptance during the Great Depression (1929 – 1941).

Employment Act of 1946 Government officially commits to positive monetary and fiscal actions to maintain economic stability. Managing the economy will be the responsibility of the President, his Advisors, and Congress.

16th Amendment – passed in 1913 makes Federal taxes legal

Discretionary vs. Automatic Discretionary fiscal policy – decisions must be made on when to use. Automatic fiscal policy – happens without decision or vote.

Types of Fiscal Policy Expansionary – increased government spending, lower taxes or a combination of both. Contractionary – lower government spending, higher taxes or a combination of both.

Problems with fiscal policy Time lags involved: – Recognition lag – Administrative lag – Operational lag

Crowding out effect Higher deficits lead to more government borrowing. This drives up interest rates. There is only so much loanable money. If the government sucks it all up, there is none left for individual investors.

Political Business Cycle – more spending in election years, and less in off years.

Net Export Effect By doing anything the government makes the situation worse. – Recession => Expansionary Policy => More government borrowing => higher interest rates => increased foreign demand for dollars => value of dollar goes up => net exports decline => GDP goes down.

Implications of a large national debt National debt is currently $16. 7 trillion $16,700,000,000,000.

How the money is borrowed. Debt is sold by the U.S. government in auctions every 3 months. 3 types of Securities are sold: – Treasury bills – short term: 90 days, 180 days, 1 year – Treasury notes – medium term: years – Treasury bonds – long term: greater than 10 years.

Who holds the U.S. Debt? U.S. Government – 52% Foreign Governments – 25% State and Local Governments Individual Investors Insurance Companies Banks and Credit Unions

Foreign Ownership of U.S. Debt Japan China United Kingdom OPEC Countries

Primary problem of a large debt Interest payments must be made annually out of Tax Revenues. This leaves less money for health care, national defense, social security, etc.