Fiscal Policy Krugman Section 4 Modules 20 and 21

Fiscal Policy Fiscal policy is done by CONGRESS—not the Federal Reserve Stabilization = Tax (T) and Spend (G) Everything equal, what puts more money in the economy, G or a decrease in T? G! People can SAVE some of a tax break

Discretionary Fiscal Policy = changes to G or T are at the option of Congress—they must make a decision! Two types :

Expansionary Policy Used to combat recession Increase G Decrease T If budget is balanced, a budget deficit is created Goal is to shift AD to the right PL LRAS SRAS PL2 PL1 AD2 AD Y1 Y2 GDPr

Contractionary Policy Used to lower inflation A decrease in G An increase in T Goal is to shift AD to the left by taking money out of the system PL LRAS SRAS PL1 PL2 AD2 AD Y2 YI GDPr

Financing Deficit Spending 1. borrow from the public Sell bonds to the public Take out loans from the public BIG GRAPH NUMBER 9 Loanable funds

Walter Mondale

2. Money Creation FED loans money directly to the gov’t or print more money increases inflation Quantity Theory of Money (MV = PY)

What to do with a Surplus 1. Pay off public debt Buy back bonds Puts $ back into the system, increases consumption May offset contractionary policy that created the surplus

2. Stand Idle (or do nothing) Withholds purchasing power No chance of inflation

Automatic Policy--Built In Stability 1. Income Tax Brackets As income increases, people pay more taxes. This limits the increase in DI and C. 2. Unemployment compensation The income of unemployed does not fall to zero. UC provides a base level of income. 3. Stocks and Bonds Dividends do not follow the swings of the business cycle. Bond payments are established at the time the bond is purchased

http://www.usdebtclock.org/

Loanable Funds Practice For Notes 1. Increase in domestic savings What happens to the rir and the Q loans? 2. Foreign sector to borrow less. 3. Private sector to save less of their disposable income. 4. Increase in private borrowing

Crowding Out ADAS If Congress deficit spends to get us out of a _________ gap, what happens to the rir? So, what happens to Ig? So, what happens to AD? So, what happens to GDP? This is called Crowding Out Big graphs 10 and 11

Phillips Curve Compares inflation and unemployment Inflation increases as U decreases more people have money ready to spend so prices increase Inflation decreases as U increases less people have money to spend so prices decrease Big Graphs 12 and 13

Phillips ADAS Practice Draw the two graphs side by side and show the changes described. Congress decreases personal income taxes. Crude oil prices increase dramatically. A new technology is introduced, immediately improving productivity. Consumers have a rapid loss of confidence.