Introduction to Fiscal Policy!

Economy = Car

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Fiscal Policy

What is it? Fiscal policy: the federal government's attempt to stabilize the economy through taxing and government spending. Fiscal policy: the federal government's attempt to stabilize the economy through taxing and government spending.

What is it? Advocates of fiscal policy believe that one of the fundamental functions of the government is to stabilize the economy.

Tools 1.Taxes 2.Government spending

Two Types Expansionary is used when AD is too low and the government may want to stimulate the economy, thus helping employment numbers. Contractionary is used when AD is too high and the government may want to slow it down, thus stabilizing prices.

AD & AS

Two Types Tight/ContractionaryEasy/Expansionary

Two Types of Fiscal Policy Type of Fiscal PolicyChange in Government Spending Change in Taxes Expansionary ↑↓ Contractionary ↓↑ and/or

Fiscal Policy and the Multiplier One aspect of fiscal policy is the expenditure multiplier in which an increase or decrease in government spending, investment spending or autonomous consumer spending has a multiplied effect on GDP. This makes fiscal policy more powerful.

The Expenditure Multiplier There is a change in spending The change in spending becomes a change in income for others Those changes in income become spending The change in spending becomes a change in income for others Etc.

G or T? Changes in G (Government spending) have greater impact on the economy than changes in taxes. Government spending is direct Taxes depend on what consumers do with the tax cut or what they would have done with the money going to pay the tax increase (how much would they consume, how much would they save?)

Crowding Out: the cost of fiscal policy Government increases spending Finances it by borrowing in credit market Interest rates go up Private investment falls Increased government spending is offset by decreased private investment

Stabilization Policies

Supply-Side Policies Supply-Side Policies “Reagonomics” “Reagonomics” Reducing the government role in the economy (deregulation) Reducing the government role in the economy (deregulation) Decreasing top tax brackets and capital gains tax Decreasing top tax brackets and capital gains tax Reduction of “safety net” Reduction of “safety net”

SUPPLY-SIDE Stimulate production (supply) to spur output Cut taxes and government regulations to increase incentives for businesses and individuals Businesses invest and expand creating jobs; people work, save, and spend more Increasing investment and productivity lead to increased output DEMAND-SIDE Stimulate consumption of good and services (demand) to spur output Cut taxes or increase federal spending to put money into people’s hands With more money, people buy more Businesses increase output to meet growing demand