 Since 1945, fiscal policy has been one of the government’s main stabilization policy tools  “active” if changes in government spending or taxes are at the option of the government  “non-discretionary” if independent of parliamentary action 1©2013 McGraw-Hill Ryerson Ltd.Chapter 11.1

 Used when Recession Occurs  Options:  Increased Government Spending  Tax Reductions  Combined Government Spending Increases and Tax Reductions  May Create a Budget Deficit 2©2013 McGraw-Hill Ryerson Ltd.Chapter 11.1

Real GDP (billions) Price level AD 2 AD 1 $5 billion increase in spending Full $20 billion increase in aggregate demand AS $490$510 P1P1 Recessions Decrease AD ©2013 McGraw-Hill Ryerson Ltd.3Chapter 11.1

 Used to Combat Demand-pull Inflation  Options:  Decreased Government Spending  Increased Taxes  Combined Government Spending Decreases and Tax Increases 4©2013 McGraw-Hill Ryerson Ltd.Chapter 11.1

Real GDP (billions) Price level AD 3 AD 4 $3 billion initial decrease in spending Full $12 billion decrease in aggregate demand AS $502 $ 522 P2P2 AD 5 $ 510 d b a P1P1 c ©2013 McGraw-Hill Ryerson Ltd.Chapter 11.15

 To expand the size of government  If recession, then increase government spending  If inflation, then increase taxes  To reduce the size of government  If recession, then decrease taxes  If inflation, then decrease government spending ©2013 McGraw-Hill Ryerson Ltd.Chapter 11.16