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Chapter 15. Using Fiscal Policy. Fiscal Policy. Fiscal Policy is the federal government’s use of taxes and government spending to affect the economy. There are three primary types: Expansionary Fiscal Policy is a plan to increase aggregate demand and stimulate the economy.
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Chapter 15 Using Fiscal Policy
Fiscal Policy • Fiscal Policy is the federal government’s use of taxes and government spending to affect the economy. • There are three primary types: • Expansionary Fiscal Policy is a plan to increase aggregate demand and stimulate the economy. • Contractionary Fiscal Policy is a plan to reduce aggregate demand and slow the economy. • Discretionary Fiscal Policy refers to actions selected by the government to stabilize the economy.
Overall Goal = Stability • There are a few tools used frequently by the government to quickly stabilize the economy (automatic stabilizers). • 1. Public Transfer Payments (the more the pay, the less they have to spend) • 2. Progressive Income Taxes (Income tax)
Expansionary Fiscal Policy • Used to increase Aggregate Demand. • Causes prices to rise. • Provides incentives to businesses in order to increase GDP. • There is a decrease in unemployment, increase in government spending, and/or a decrease in taxes.
Contractionary Fiscal Policy • Used to reduce inflation or when the economy is growing too rapidly. • Decrease in government spending and an increase in taxes in order to control inflation. • Creates a trickle down effect where people have less money to spend so they do not over buy items.
Limitations of Fiscal Policy • #1 Policy Lags: Congress can take longer than needed to act. • #2 Timing Issues: It has to match up with the business cycle. • #3 Rational Expectations Theory: This accounts for people acting ahead of time because they predict coming changes. • #4 Political Issues: Often times leaders act to get reelected not always to provide the best answer. • #5 Regional Issues: Not all parts of a country may face the same economic issues.
Demand-Side Economics • Developed from the ideas of economist John Maynard Keynes who believed economic issues should be solved with government action. • The focus is to increase aggregate demand as a way of improving the economy.
Keynesian Theory • Keynes believed that changes in demand influenced the business cycle. • He focused on investment as the key out of the GDP equation. • By increasing investment, Keynes believed that there would be a spending multiplier effect where a small change would have a great impact.
Government and the Demand-Side • With Demand-Side Fiscal Policy, the government must make choices to increase demand and control inflation. • Keynes proposed a highly active government that used and expansionary policy to seek full employment. • The downside is although this works for recovery, it is hard to slow down after the recovery.
Supply-Side Economics • The goal of supply-side policies is to provide incentives to producers to increase aggregate supply. • Supply-Side economics favors less government involvement in the areas of taxation, spending, and regulation.
The Laffer Curve and its’ Effects • The Laffer Curve is a graph that illustrates the economist Arthur Laffer’s theory of how tax cuts affect tax revenues. • The idea is that when taxes go beyond a certain point, revenue decreases because people lose the incentive to work.
Federal Deficit and Debt • A budget surplus is when the government takes in more revenue tan it spends and budget deficit is the opposite. • Deficit Spending is the government practice of spending more money than it takes in a given year. The growing annual deficits add up to the national debt. • http://www.usdebtclock.org/
Causes of Deficit • #1 National Emergencies • #2 Need for Public Goods and Services (ex. Infrastructure) • #3 Stabilization of the Economy: Government Programs and Bail Outs • #4 Role of Government in Society (ex. Social Security)
Money for Deficit Spending • When the government does not receive enough revenue it can borrow in 3 forms. • #1 Treasury bills mature in less than 1 year • #2 Treasury notes mature between 2 and 10 years • #3 Treasury bonds mature in 30 years
Effect of the Debt on the Economy • One major effect is the crowding out effect where the government owns more in bonds than private owners do.