Ch 11: Fiscal Policy

Fiscal Policy: Changing the amount of Government Spending or Taxes Collected in order to direct an economy

2 Types of Fiscal Policy: 1 2 Types of Fiscal Policy: 1. Discretionary – policies that are enacted due to current economic problems 2. Nondiscretionary - policies that are built into the system

3 Questions to answer: 1. What fiscal policy should we use. 2 3 Questions to answer: 1. What fiscal policy should we use? 2. When should we use fiscal policy? 3. What problems do we face when using fiscal policy?

Fiscal policy can be used either to increase or decrease AD Fiscal policy can be used either to increase or decrease AD. ↓ T or ↑ G increases AD ↓ G or ↑ T decreases AD

P AS AD= C+I+G+NX RGDPC F.E. RGDP Rec. GAP

The proper fiscal policy during a recessionary gap is to either increase government spending or cut taxes The goal is to increase AD until you are back at F.E.

P AS AD’ AD= C+I+G+NX RGDPC F.E. RGDP Rec. GAP

Which policy you suggest may depend on your political ideology Which policy you suggest may depend on your political ideology. Liberals like to increase G Conservatives like to cut T

The Pros: 1. You decrease unemployment 2. You increase RGDP The Cons: 1. You increase inflation 2. You increase Gov. Debt

P AS AD F.E. RGDPC RGDP Infl. GAP

The proper fiscal policy during an inflationary gap is to either decrease government spending or raise taxes The goal is to decrease AD until you are back at F.E.

P AS AD=C+I+G+NX AD’ F.E. RGDPC RGDP Infl. GAP

Which policy you suggest may depend on your political ideology Which policy you suggest may depend on your political ideology. Liberals like to increase T Conservatives like to cut G

The Pros: 1. You decrease inflation 2. You decrease Gov The Pros: 1. You decrease inflation 2. You decrease Gov. Debt The Cons: 1. You increase unemployment 2. You decrease RGDP

P AS AD=C+I+G+NX RGDPC F.E. RGDP STAGFLATION

The proper fiscal policy during stagflation depends on which problem you want to fix; both unemployment and inflation are problems. You can only solve one problem by making the other one worse.

If you want to solve unemployment, then increase G or cut T, shifting the AD curve to the right It will create even more inflation.

P AS AD’ AD=C+I+G+NX RGDPC F.E. RGDP STAGFLATION

The Pros: 1. You decrease unemployment 2. You increase RGDP The Cons: 1. You increase inflation a lot 2. You increase Gov. Debt

If you want to solve inflation, then increase T or cut G, shifting the AD curve to the left It will create even more unemployment.

P AS AD’ AD=C+I+G+NX RGDPC F.E. RGDP STAGFLATION

The Pros: 1. You decrease inflation 2. You decrease Gov The Pros: 1. You decrease inflation 2. You decrease Gov. Debt The Cons: 1. You increase unemployment – a lot 2. You decrease RGDP

Problems with Fiscal Policy: 1. Policy isn’t instantaneous a Problems with Fiscal Policy: 1. Policy isn’t instantaneous a. recognition lag: the time it takes to realize a problem exists

Administrative lag – the time it takes for Congress and the President to come up with a solution c. Operational lag – the time it takes for the policy, once enacted, to be felt in the economy

2. Politicians are in charge of fiscal policy, not economists a 2. Politicians are in charge of fiscal policy, not economists a. Politicians are motivated by re-election, not the long-term health of the economy b. Politicians are morons

Automatic Stabilizers = non-discretionary fiscal policy things that help the economy come back to F.E. without a vote ex: income tax; unemployment insurance; welfare