Fiscal Policy

Definition O Fiscal policy includes the use of government spending and tax policies to facilitate the government’s mandate. O By mandate we include the government’s goals and objectives as outlined in their election platform

Stabilization Policy O The goal of all stabilization policies is to stabilize the national income (GDP) at or near the desired level which is that of full employment. O The government can use its ability to tax, borrow or alter the circular flow of income in the economy as it sees fit. O Expansion or contraction may be the goal

Recall this picture Full employment is the line in the middle. If you look at the aggregate supply curve, it represents price levels in our economy. The aggregate demand curve represents the GDP. GDP as a measure in the expenditure approach is calculated as C+G+I (X-M).

If GDP Rises Too Quickly? (Inflationary Gap) O If GDP rises too quickly, it enters in the inflationary gap. O The inflationary gap indicates that we are inflating our country’s price levels (inflation of our money). O The government will most likely enact a policy that will cause the GDP to shrink or retract/contract to the full employment line

Contractionary Policy O When the economy is in an inflationary gap, the government will implement policy that will allow for the following: a. Tax Increase - A tax increase will remove money from consumer’s pockets. By doing so, the Consumer Spending component of the GDP will reduce, thus causing the aggregate demand to move back towards full employment b. Decrease in government spending - The decrease in government spending would see fewer roads built, closure of hospitals etc. Contractionary policy is often considered controversial in our democratic society because any government who raises taxes or cuts jobs will be unpopular and thus reduce the chances of being re-elected.

If GDP slows down? (recessionary gap) O GDP moves toward the recessionary gap, the government will enact expansionary fiscal policy which will cause the economy to head back to full employment.

Expansionary Policy a. Tax cut - This will increase the disposable incomes of consumers which will lead to increased spending. This increased spending will allow the Consumer Spending component of the GDP formula to grow, thus causing the aggregate demand curve to move to the full employment position. b. Increase in government spending - The increase in government spending could see the creation of new jobs. For example, Jean Chrétien’s government created many jobs in the health care field in the 1990`s which affected the government spending section of the GDP formula.

Business Cycle O As it moves up and down, different factors are affected: as the cycle moves toward its peak, the economy is expanding, unemployment is low and inflation is increasing. O After the peak, the economy is contracting, meaning there is higher unemployment, shrinking money supply, and the economy is adjusting.

More Tools of Fiscal Policy Automatic Stabilizers: O These are programs put in place by the government which help ‘’soften’’ the blow of moves in the business cycle. These programs are already in place and do not require the government to do anything. O In difficult economic periods, some people lose their jobs. Employment insurance provides some income for these people allowing the effects of a recession to be less severe.