fiscal policy Daniel Begazo Lily Zhang Sabrina Tan

What is Fiscal Policy?  Fiscal policy refers to the government’s response to inflation and/or recession in an economy  They accomplish this through implementing contractionary or expansionary policies  The tools they use are spending and taxing

Economic Issues Recession  A recession is a period of temporary economic decline characterized by a drop in GDP and employment Inflation  A period of inflation is characterized by a general increase in prices and a fall in the purchasing power of money

DEMAND-SIDE EFFECTS

How do we fix the problem? Here are some solutions! Recession (expansionary policies)  Government reduces taxing  Government increases spending Inflation (contractionary policies)  Government increases taxing  Government decreases spending

Graphs of Effects of Policies Recessionary Gap Inflationary Gap

SUPPLY-SIDE EFFECTS

STAGFLATION Graph  Occurs whenever the aggregate supply curve shifts to the left Solutions  Supply-side economics is an attempt to cure stagflation  Economists recommend special tax policies and less government regulations  Fiscal policy alone is not enough to solve this problem so the FED implements monetary policies as well which is known as policy mixing

FORMULAS

Calculating the Effects Spending Multiplier  A measure of the change in aggregate consumption which occurs when one person’s consumption affects another’s and so on Tax Multiplier  A measure of the change in aggregate production caused by changes in government taxes SM= 1/(MPS+MPI) TM= -(MPC- MPI)/(MPS+MPI)

COMPLICATIONS Reasons why policies can be ineffective

Crowding Out  This occurs when the gov. increases spending in a recession that causes them to run a deficit  The result of this is the gov. borrowing money from banks and banks increasing interest rates  Ironically, increased interest rates, causes people to spend less so this cancels out the effect of increased gov. spending

Role of Expectations Theory  Based on the idea that households and businesses take all available info into account when making decisions  Implies that fiscal policy will be ineffective at changing of output Example  The gov. uses expansionary policy  People understand that gov will deficit spend  Deficit spending=higher prices in the future  Less people work and less products are produced now in anticipation of higher wages and prices  Unfortunately, this cancels out the effect of the implemented policies

Types of Inflation Demand-Pull  “too many dollars chasing too few goods”  For example, an economy reaches its maximum production level and the supply of goods and services doesn’t meet the demand of consumers. The costs go up due to an increase in demand and a shortage in supply. Cost-Push  Increases in production costs that cause firms to raise prices to avoid losses  An example is when workers demand an increase in wages. When this occurs, the businesses need to raise the prices of their goods and services to diminish any loss in profit.

Phillip’s curve

The Phillips Curve  The Phillips tradeoff is the inverse relationship between inflation and unemployme nt.  The Phillips Curve provides a visual for this concept

The Phillips Curve Short Run Long Run In the short run, there is an inverse relationship between inflation rates and unemployment rates In the long run, unemployment stays the same and inflation is the only factor that changes

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