FISCAL POLICY Inflation Real GDP AS 1 AD 1 AD 2 Economy in recession, Unemployment = 9.1% Expansionary Fiscal Policy needed Lower Taxes & ↑ Gov’t spending C ↑ & G ↑ => AD shifts right End result: higher GDP, more Jobs & slightly higher inflation

Macroeconomic Theories Classical, Keynesian & Supply Side Economics

Economists often Disagree Are tax cuts good or bad? Do Large Deficits always raise interest rates? Will taxing “rich” people significantly lower GDP? IT DEPENDS! The answer to most economic questions is:

2013 U.S. Economy Economy well below full potential What Now? Tax Cuts? Gov’t Spending? New Incentives? Self-Regulation? AD 1 Inflation Real GDP AS 1

Protests In France & Greece Turn Violent Europe & Austerity Austerity = Extreme Gov’t budget cuts & tax increases Often AFTER crowding out!

Classical vs. Keynesian Reading

CLASSICAL Economists –Markets are naturally self regulating –No government intervention necessary –Recessions are temporary –Great Depression challenged Classical View Classical economists were the 1 st school of economic thought starting in 1776 Adam Smith was the founder and they believed:

John Keynes Founder of Keynsian Economics –Greatly influenced Fiscal Policy after the Great Depression Believed recessions could be permanent Argued investment by Government can moderate the “ups & downs” of business cycle

Theory – Period Challenged Classical Theory - Great Depression (1929) Keynesian Economics - Stagflation (late 1970’s) Neo-Classical Theory Great Recession (2008)

Keynes-Stimulus Debates Economists argue over the benefits/costs of both expansionary Fiscal Policy Benefits Costs/Risks

Austrian Economics Friedrich Hayek (1899 – 1992) –Austrian School of Economics Against active Fed Policy Promoted “self regulation” of free market Believed low interest rates led to Malinvestment

Jobless Recovery recovery-and-a-lost-generation/ recovery-and-a-lost-generation/

Supply-Side Policy Basic Belief: Government Incentives Matter Goal: use incentives to encourage new business! –shift the aggregate supply curve right –when PPF shifts right => AS shifts right The supply-side toolbox consists of: –Tax cuts to stimulate work, saving, and investment (I↑) –Deregulation to reduce production cost/stimulate investment. –Expenditures on education training/research expands capacity to produce

GDP What creates Economic Growth? INCENTIVES MATTER!!! Classical, Keyensian and Supply Side Economists approach the same economic problems in different ways!

AD 1 Inflation Real GDP AS 1 Growing GDP in the Long Run U.S.PPF Graph

Innovation