Fiscal Policy

Fiscal Policy A government’s policy on taxes and spending Increased government spending and/or lower tax rates help to fight recessions

Fiscal Policy Concerns itself with how governments tax and spend. Many governments have opportunities to increase aggregate demand by making changes in fiscal policy. Def: Changes governments make in spending or taxation in order to achieve a particular economic goal 2 types of Fiscal Policy: expansionary and contractionary

Expansionary Fiscal Policy and the Problem of Unemployment

High unemployment rate is the result of people not spending enough money in the economy People spend more money, firms sell more goods, firms can hire more people to produce the goods thus leading to a lower unemployment rate To reduce the unemployment rate, Congress should implement expansionary fiscal policy Congress can create fiscal policy that increases government spending, lower taxes, or both.

Increase government spending This means more money in the economy by spending more on health care, education, national defense, and many other programs. Example Suppose the current prices the government is spending is $1,800 billion, business is spending $1,200 billion, and consumers are spending $6,000 billion. Total spending at current prices is $9,000 billion If the government decides to increase spending by $200 billion, then total spending increases to $9,200 billion.

As a result of the increase in total spending, firms sell more goods When firms start to sell more goods, they have to hire more workers to produce the additional goods. The unemployment rate goes down as a result of more people working.

Short-term consequence: More money is circulating in the economy Unemployment goes down Long-term consequence: Crowding out: the situation in which increases in government spending lead to reductions in private spending Because the government is now spending money on something it wasn’t spending on before, the private sector is no longer spending money on it.

Contractionary Fiscal Policy and the Problem of Inflation Inflation: an increase in the price level (total level of prices) Inflation is the result of too much spending in the economy compared to the quantity of goods and services available for purchase

Economic Recessions & Monetary and Fiscal Policy

What is recession? Defined as two consecutive quarters during which output falls and unemployment rises Why are recessions bad? High toll on human suffering When output falls, firms need fewer workers This leads to massive layoffs, leading to a significant increase in unemployment Surplus in goods means wasted resources

Recessions take a long time to resolve If the government takes no action to end a recession, the only way for the economy to return to producing at the full- employment output level is for prices to drop so that the economy’s equilibrium will also drop This process is very slow, and as a result, the economy will often have high unemployment for a very long time unless the government gets involved

What you should be doing now Fiscal policy homework Final project Note: If you are missing an assignment, you have until 3:00 today I will not accept any late work after today at 3:00