1. Fiscal Policy
Economics
Mr. Bordelon

2. Fiscal Policy Tools KEY CONCEPTS
Fiscal—refers to government revenue, spending, and debt
Fiscal policy—government’s use of taxes, spending to affect economy
Expansionary fiscal policy—raises aggregate demand, stimulates economy
Contractionary fiscal policy—reduces aggregate demand, slows economy
Federal government’s tools to influence economy: taxation, spending

3. Fiscal Policy Tools Discretionary Fiscal Policy
Discretionary fiscal policy—actions government takes to stabilize the economy
involve choices government makes about taxes or spending
Congress must enact legislation for policies to be implemented

4. Fiscal Policy Tools Automatic Stabilizers
Automatic stabilizers—fiscal policy features that work automatically
control aggregate demand in expansionary or contractionary manner
Public transfer payment programs (unemployment) and progressive income taxes
increase incomes and reduce impact of a recession
reduce extra income entering economy, slow growth, check inflation

5. The Purpose of Fiscal Policy
Policy 1: Expansionary Fiscal Policy
Expansionary policy increases aggregate demand so economy can grow
Increased spending on public projects done by hiring private firms
jobs created; workers spend on goods and services
Lower personal, corporate income taxes leaves more money available
increase in demand for products, saving, capital and labor investment

6. The Purpose of Fiscal Policy
Policy 2: Contractionary Fiscal Policy
Too rapid economic growth leads to demand-pull inflation
Spending cuts mean less income for private firms working for government
aggregate demand drops; production drops; inflation is controlled
Higher taxes reduce disposable income
decreases consumer spending, production; workers laid off; prices drop

7. Limitations of Fiscal Policy
Limitation 1: Policy Lags
Fiscal policy lags behind conditions it is meant to address
May take time to identify problem and to get Congress to act
Implementing policy change takes time
tax changes can take effect faster than new spending programs

8. Limitations of Fiscal Policy
Limitation 2: Timing Issues
Fiscal policy meant to smooth out peaks and troughs of business cycle
If timing is good, fluctuations in the business cycle are less severe
If timing is bad, policy can make matters worse. Example:
if moving out of recession, expansionary policy can bring on inflation

9. The Federal Deficit and Debt
KEY CONCEPTS
Budget surplus occurs when government takes in more than it spends
Budget deficit occurs when government spends more than it takes in
Deficit spending—spending more than revenues for specific budget year
National debt—the total amount of money the government owes

10. The Federal Deficit and Debt
Causes of the Deficit
Four main reasons for deficit spending
— national emergencies usually require massive spending beyond normal budget
— building public goods and services is expensive, work takes years
— public projects to stimulate, stabilize weak economy need large sums
— entitlement programs that people depend on are expensive

11. The National Debt The Current Debt
In August 2006, national debt about $8.4 trillion
federal deficits and debt increased during 1980s, 1990s
since 1980s debt has grown faster than inflation—grown in real terms
In 1981, debt was 33 percent of GDP; in 2006 was nearly 68%
in 1981, about 80 percent privately owned; in less than 60% private

12. The National Debt The Effect of the Debt on the Economy
If government spending stimulates economy, jobs and public goods created
If government outbids private sector, pays higher bond interest rates
crowding-out effect—money leaves private sector, interest rates rise
Constant borrowing increases total interest and taxes to service debt
higher taxes decrease consumer spending and business investment