The Government has two different tool boxes it can use: 1. Fiscal Policy- Actions by Congress to stabilize the economy. OR 2. Monetary Policy- Actions by the Federal Reserve Bank to stabilize the economy. 2 How does the Government Stabilizes the Economy?

For now we will only focus on Fiscal Policy. 3

Fiscal Policy 4 Actions taken by Congress to stabilize the economy Business

There are two types of Fiscal Policy Discretionary Fiscal Policy and Non-Discretionary Fiscal Policy “Use your discretion” discretion - the power or right to decide or act according to one's own judgment; freedom of judgment or choice

Ex: In a recession, Congress increase spending in order to increase GDP. 5 Discretionary Fiscal Policy Congress chooses to take Action or create Legislation designed to affect GDP and stabilize the economy Tools: Government Spending and Taxation Problem: It takes time for Congress to decide and act

Ex: In a recession, Congress increase spending in order to increase GDP. increased government spending increased productivity and money into economy more jobs and income for employees more money money spent in private business and industry results in increased productivity and employment in entire economy Increased Government Spending = Increased GDP

Ex: Welfare, Unemployment, Min. Wage, etc. 5 Non-Discretionary Fiscal Policy AKA - “Automatic Stabilizers” Permanent spending or taxation laws created to work counter cyclically to stabilize the economy laws and programs designed to automatically step in when the economy begins to shift

Non-Discretionary Fiscal Policy Legislation that act counter cyclically without explicit action by policy makers. AKA: Automatic Stabilizers The U.S. Progressive Income Tax System acts counter cyclically to stabilize the economy. When GDP is down, the tax burden on consumers is low, promoting consumption, increasing AD. When GDP is up, more tax burden on consumers, discouraging consumption, decreasing AD. The more progressive the tax system, the greater the economy’s built-in stability. 9

The Economy Is Like A Car Sometimes it’s moving too slow... and we need something to speed it up... Sometimes it’s moving to fast!!! and we need something to slow it down!!!! We want the economy moving at a steady pace

Laws that reduce inflation, decrease GDP (Close an Inflationary Gap) Decrease Government Spending Tax Increases Combinations of the Two Contractionary Fiscal Policy (The BRAKE) Laws that reduce unemployment and increase GDP (Close a Recessionary Gap) Increase Government Spending Decrease Taxes on consumers Combinations of the Two Expansionary Fiscal Policy (The GAS) How much should the Government Spend? 7