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Fiscal Policy, Deficits, and Debt
Ch 17
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Fiscal Policy and Potential Output
Potential Output- economy’s maximum sustainable output in the long run (full employment output) Recession gap- output below potential in short run Expansionary gap- output exceeding potential (Black Friday)
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Rise of Fiscal Policy Classical economists- Laissez-faire, hands off, Adam Smith Annual balanced budget The Great Depression and Keynes The Multiplier Effect- any change in fiscal policy affects aggregate demand by more than from original change in spending or taxes Increase in government spending, or cutting taxes increases aggregate demand
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Rise of Fiscal Policy WWII spending puled us out of the depression
Employment Act of 1946 Promote full employment and price stability 2009 Stimulus Package designed to increase aggregate supply
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Fiscal Policy Tools Discretionary fiscal Policy- requires congressional and presidential action to change government spending or taxes Automatic Stabilizers- taxing and spending programs, adjust to ups and downs to stabilize disposable income(post tax income) Unemployment insurance Welfare payments Progressive income tax
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Problems with discretionary fiscal policy
Stagflation- decrease in aggregate supply causing increase in inflation and unemployment Fiscal Policy and Aggregate Supply
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Problem of Lags Recognition lag Decision-Making Lag Implementation Lag
Effectiveness Lag
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Great Recession Dec 2007 US economy Entered Recession
Housing Bubble Burst Foreclosures Less loans
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Fiscal Policy During the Great Recession
TARP bill enacted to stimulate economy in early 2008 $168 Billion $600 one time tax rebate Most saved rebate and didn’t spend it 2nd Quarter 190,000 jobs lost 3rd Q 334,000 jobs lost
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Recovery Act of 2009 Obama elected president
Recovery Act of 2009 sighed in February $787 billion stimulus package 37% tax benefits 28% funded entitlements (such as Medicaid) 35% Grants contracts and loans (”shovel ready” infrastructure projects) Aimed at aggregate Supply
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