Chapter 15 Fiscal Policy

Demand-Side Economics Until Great Depression, government did little to influence economy persistent unemployment, low production changed many economists’ minds John Maynard Keynes proposed Keynesian economics: idea that during recession government should stimulate aggregate demand basis of demand-side fiscal policy—policy to stimulate aggregate demand

Demand-Side Economics Keynesian Theory Changes in aggregate demand affect business cycle: GDP = C+I+G+F GDP = consumer (C), investment (I), government goods (G), net exports (F) exports small role in the economy; consumer, government spending stable Keynes believed investment caused fluctuations in the economy spending multiplier effect—a spending change results in larger GDP change

Government and Demand-Side Policies The Role of Government Depression economy stable, but high unemployment, little aggregate demand Keynes argued for government spending to create jobs, increase income also lower taxes to encourage consumer spending, business investment During inflation Keynes favored decreased spending, raised taxes

Government and Demand-Side Policies Sometimes demand-side policies work; example, World War II production Difficult to discontinue popular programs after recession Difficult for politicians to raise taxes during inflationary periods Demand-side policies ineffective for stagflation slow economic growth with unemployment and inflation

Supply-Side Economics The Role of Government Supply-side economists favor cutting individual, corporate taxes to encourage people to work, save, invest more reducing highest tax brackets frees income to most likely investors Favor lower government spending: if need less revenue, can lower taxes Favor less regulation: cuts production costs, ups aggregate supply

The Federal Deficit and Debt All levels of government struggle to achieve balanced budget Budget surplus occurs when government takes in more than it spends Budget deficit occurs when government spends more than it takes in Deficit spending—spending more than revenues for specific budget year National debt—the total amount of money the government owes

The Federal Deficit and Debt Causes of the Deficit Four main reasons for deficit spending — national emergencies usually require massive spending beyond normal budget — building public goods and services is expensive, work takes years — public projects to stimulate, stabilize weak economy need large sums — entitlement programs that people depend on are expensive

The National Debt The Current Debt In August 2006, national debt about $8.4 trillion federal deficits and debt increased during 1980s, 1990s since 1980s debt has grown faster than inflation—grown in real terms In 1981, debt was 33 percent of GDP; in 2006 was nearly 68% in 1981, about 80 percent privately owned; in 2006 less than 60% private

Is the Federal Deficit Too Large Background pg. 370 Taxpayers ultimately pay the interest on the national debt, which is created by deficit spending by the federal government. The government uses deficit spending for several reasons, including paying for national emergencies and implementing expansionary fiscal policies during periods of recession. What’s the Issue Is the federal deficit too large? Thinking Economically (Documents: Sky Not Falling; Entitlement Issues; Dangers) Identify the economic cause-and-effect relationships described in Documents A and C. How does Document B illustrate the challenge facing the Bush administration in its efforts to carry out the plan discussed in Document C? Do you think the Bush administration shares the concerns about the deficit expressed in Document A? Use information from the documents to explain your answer.