Krugman Section 4 Modules 20 and 21 Fiscal Policy

Why do we use money? Why is there money?—by Steve Reff Why is there money?

Fiscal Policy Video Segment

Fiscal Policy Fiscal policy is done by CONGRESS—not the Federal Reserve Stabilization is done by G and Tax (T) collection  Everything equal, what puts more money in the economy, G or a decrease in T?  G! People can SAVE some of a tax break

The Employment Act of 1946 Congress proclaimed gov’t role in promoting max. employment, production and purchasing power  Keynesian Economics Created the Council of Econ. Advisors to advise the President Created the Joint Economic Committee of Congress to investigate econ. problems.

Discretionary Fiscal Policy = changes to G or T are at the option of Congress Two types = expansionary and contractionary

Expansionary Policy Used to combat recession Increase G Decrease T If budget is balanced, a budget deficit is created Goal is to shift AD to the right PL GDPr AD SRAS AD2 Y1 PL1 Y2 PL2 LRAS

Contractionary Policy Used to lower inflation A decrease in G An increase in T Goal is to shift AD to the left by taking money out of the system PL GDPr AD SRAS AD2 YI PL1 Y2 PL2 LRAS

Financing Deficit Spending 1. borrow from the public  Sell bonds to the public: take out loans

2. Money Creation  FED loans money directly to the gov’t  Could increase inflation

What to do with a Surplus 1. Pay off public debt  Buy back bonds Puts $ back into the system, increases consumption May offset contractionary policy that created the surplus

2. stand idle  Withholds purchasing power  No chance of inflation

Automatic Policy--Built In Stability 1. Income Tax  As income increases, people pay more taxes. This limits the increase in DI and C. 2. Unemployment compensation  The income of unemployed does not fall to zero. UC provides a base level of income. 3. Stocks and Bonds  Dividends do not follow the swings of the business cycle. Bond payments are established at the time the bond is purchased