How can policymakers influence the economy?

A C C C A Predict what you think the effect of each possible action might be. Choose from:

Each action you considered is a tool available to policymakers for stabilizing the economy. These tools can be used as a part of fiscal or monetary policy to stimulate the economy during a contraction or to slow the economy during an expansion. During the next 2 days, we will learn how the fiscal policy of the federal government and the monetary policy of the Federal Reserve are used to stabilize the U.S. economy.

Fiscal Policy

The use of taxation and government spending to control the economy!!! FISCAL POLICY: The use of taxation and government spending to control the economy!!!

Consider this situation: Output (GDP) is down Many people are getting laid off from their jobs People have less discretionary income, so aggregate demand (spending) is down Businesses continue to suffer and are forced to lay off more and more workers WHAT SHOULD THE GOVERNMENT DO?

Encourage Economic Growth! Increase aggregate demand!!! Prices will rise Suppliers will want to produce more People will get hired back to their jobs People will feel comfortable spending money again The economy will expand 

EXPANSIONARY FISCAL POLICY We call this… EXPANSIONARY FISCAL POLICY Tool #1: Tool #2: INCREASE GOVERNMENT SPENDING CUT TAXES Government buys more goods & services Companies that sell goods to the government earn profits, which they use to pay their workers more & hire new workers Workers have more money & spend more in shops & restaurants Shops & restaurants buy more goods and hire more workers to meet their needs In the short term, government spending leads to more jobs and more output When tax rates go down, individuals have more money to spend and businesses keep more of their profits Consumers now have more money to spend on goods and services Businesses now have more money to spend on land, labor and capital These actions will increase demand, prices, and output

Now, consider this situation: Fast-growing demand is exceeding supply Producers who cannot increase output levels are forced to increase their prices Inflation occurs, cutting into consumers’ purchasing power & discouraging economic growth and stability WHAT SHOULD THE GOVERNMENT DO?

Slow Down Economic Growth! Decrease aggregate demand!!! Keep prices low Suppliers will cut production/lay off workers Lower production will slow the rate of growth of the economy Inflation will not occur GDP may even decline

CONTRACTIONARY FISCAL POLICY We call this… CONTRACTIONARY FISCAL POLICY Tool #1: Tool #2: DECREASE GOVERNMENT SPENDING INCREASE TAXES Government buys less goods & services There is a decrease in aggregate demand because the government is buying less than before Prices of goods and services drop Suppliers produce less & possibly fire workers Lower production slows down the rate of growth of the economy Individuals have less money to spend on goods & service, or to save for the future Businesses keep less of their profits and decrease their spending on land, labor, and capital As demand decreases, prices fall Suppliers produce less & possibly fire workers Lower production slows down the rate of growth of the economy

QUIZ: EXPANSIONARY! CONTRACTIONARY! What type of fiscal policy should be enacted when we are in an economic recession? 2. What type of fiscal policy should be enacted when high inflation is a problem? EXPANSIONARY! (Increase Government Spending or Cut Taxes) CONTRACTIONARY! (Decrease Government Spending or Increase Taxes)

Fiscal Policy Q&A

Why does Fiscal Policy work? Multiplier Effects: Government interventions trigger a “domino” effect Increased spending by consumers, businesses, or government becomes income for someone else. When this person spends the income, it becomes income for someone else, and so on This leads to increased production Multiplier effects can also work in reverse when spending decreases

How large are the multiplier effects? It is important to know this to decide how large the initial change in taxes and government spending must be to effectively fight recession or inflation. Too large a change could cause more problems Too small a change would not solve anything Unfortunately, economists do not know precisely how large multiplier effects are 

How fast does fiscal policy work? Time lags frequently occur with fiscal policy because of the time it takes… Economists cannot predict how long these lags will be and therefore cannot predict how long it will take fiscal policy to help the economy  a) to realize there is a problem in the economy b) to get a change in taxes or spending policy passed by Congress c) for the fiscal policy to affect the recession or inflation

What are the limits of Fiscal Policy? Increasing/decreasing the amount of federal spending is not an easy task! The meaning of statistics are not agreed upon & lawmakers cannot decide what type of fiscal policy action to take! The results of fiscal policy are often delayed, so it’s hard to know if it worked, didn’t work, or just hasn’t worked yet! The President/Lawmakers want to get re-elected and may cut taxes/increase government spending even when it’s not the best thing for the economy! Coordination between all levels of government is difficult.