Fiscal Policy Controlled by the US Government (Congress and the President) 2 Primary Tools Government Spending Taxes

Fiscal Policy Changes in Government Spending affect G Changes in Taxes affect C Is this supply-side or demand-side policy? Fiscal policy is only effective at correcting shifts of AD

Fiscal Policy Expansionary Response to recession/unemployment When output is to the left of Y* Increase G and/or Decrease T Increases AD Brings output back to Y*

Fiscal Policy Contractionary Policy Response to inflation When output is above Y* Decrease G and/or Increase T Decreases AD Brings output back to Y*

Fiscal Policy Automatic Stabilizers Adjust without action by Congress Examples: Income Tax System Unemployment Compensation

Problems of timing (Lag-time) Recognition Lag: The time between the beginning of recession or inflation and the awareness that it is actually occurring. This happens because of the difficulty in predicting the future course of economic activity

Problems of timing (Lag-time) Administrative Lag: The time between the recognition of the need for fiscal action and the time action is taken. This is the downside of democracy 9/11/01, the U.S. Congress was stalemated for two months before passing an economic stimulus law

Problems of timing (Lag-time) Operational Lag: Occurs between the time when fiscal action is taken and when the action takes effect on output, employment, or the price level. While tax rates can be implemented quickly, government public works require long planning periods and longer periods of construction