Fiscal Policy, Deficits, and Debt Ch 17

Fiscal Policy and Potential Output Potential Output- economy’s maximum sustainable output in the long run (full employment output) Recession gap- output below potential in short run Expansionary gap- output exceeding potential (Black Friday)

Rise of Fiscal Policy Classical economists- Laissez-faire, hands off, Adam Smith Annual balanced budget The Great Depression and Keynes The Multiplier Effect- any change in fiscal policy affects aggregate demand by more than from original change in spending or taxes Increase in government spending, or cutting taxes increases aggregate demand

Rise of Fiscal Policy WWII spending puled us out of the depression Employment Act of 1946 Promote full employment and price stability 2009 Stimulus Package designed to increase aggregate supply

Fiscal Policy Tools Discretionary fiscal Policy- requires congressional and presidential action to change government spending or taxes Automatic Stabilizers- taxing and spending programs, adjust to ups and downs to stabilize disposable income(post tax income) Unemployment insurance Welfare payments Progressive income tax

Problems with discretionary fiscal policy Stagflation- decrease in aggregate supply causing increase in inflation and unemployment Fiscal Policy and Aggregate Supply

Problem of Lags Recognition lag Decision-Making Lag Implementation Lag Effectiveness Lag

Great Recession Dec 2007 US economy Entered Recession Housing Bubble Burst Foreclosures Less loans

Fiscal Policy During the Great Recession TARP bill enacted to stimulate economy in early 2008 $168 Billion $600 one time tax rebate Most saved rebate and didn’t spend it 2nd Quarter 190,000 jobs lost 3rd Q 334,000 jobs lost

Recovery Act of 2009 Obama elected president Recovery Act of 2009 sighed in February $787 billion stimulus package 37% tax benefits 28% funded entitlements (such as Medicaid) 35% Grants contracts and loans (”shovel ready” infrastructure projects) Aimed at aggregate Supply