Fiscal Policy © Robin Foster

Mechanics of Fiscal Policy- Discretionary Policy AP Macro

Fiscal Policy Government Spending==This means Congress . This is the use of either government purchases of goods and services or tax policy to stabilize the economy This is the “G” in the calculation of the GDP

Fiscal Policy Government efforts to promote full employment and price stability by changing government spending (G) and/or taxes (T). Recession is countered with expansionary policy. Increase government spending (G ) Decrease taxes (T ) Inflation is countered with contractionary policy Decrease government spending (G ) Increase Taxes (T )    

Fiscal Policy In a recession—expansionary fiscal policy to Increase AD In a period of inflation— contractionary fiscal policy to Decrease AD

How does Fiscal Policy work? Recession Inflation Increase GS to Increase AD Decrease taxes to Increase DI to increase AD. Increasing GS and decreasing T….side effect increasing national debt. Decrease GS to decrease AD Increase taxes to decrease DI to decrease AD Decreasing GS and increasing taxes….side effect, either a budget surplus…..this means idle debt or pay off debt

Expansionary Fiscal Policy SRAS LRAS PL  P1  P AD1 AD  Y YF GDPR IF RECESSION, THEN G↑.: AD  .: GDPR↑ & PL↑ .: u%↓ & π% ↑ OR T↓ .: DI↑ .: C↑.: AD  .: GDPR↑ & PL↑ .: u%↓ & π% ↑

Contractionary Fiscal Policy LRAS PL SRAS  P  P1 AD AD1  YF Y GDPR IF INFLATION, THEN G↓ .: AD  .: GDPR↓ & PL↓ .: u%↑ & π%↓ OR T↑ .: DI↓ .: C↓ .: AD  .: GDPR↓ & PL↓ .: u%↑ & π%↓

Discretionary v. Automatic Fiscal Policies Increasing or Decreasing Government Spending and/or Taxes in order to return the economy to full employment. Discretionary policy involves policy makers doing fiscal policy in response to an economic problem Automatic Unemployment compensation & marginal tax rates are examples of automatic policies that help mitigate the effects of recession and inflation. Automatic fiscal policy takes place without policy makers having to respond to current economic problems.

Weaknesses of Fiscal Policy Lags Inside lag – it takes time to recognize economic problems and to promote solutions to those problems Outside lag – it takes time to implement solutions to problems Political Motivation Politicians face re-election and are more likely to support expansionary rather than contractionary fiscal policy. Increased government spending and decreased taxes are almost always more popular with voters than increased taxes and decreased spending.

Government Lags Recognition-Aware a recession is happening? Administrative-democracy is slow to move. Operational-time between actual and efforts occur with output, employment or price level. Political business cycle-fiscal policy is political, election years, etc.

Automatic Stabilizers-Non-Discretionary Policy Support the economy during recessions Help economy from becoming overheated during inflationary periods Example: tax revenues fall as GDP falls during a recession, this prevents consumption preventing the economy from falling further. Transfer payments are automatic stabilizers: unemployment, food stamps, etc.