Chapter 7. Fiscal Policy. These slides supplement the textbook, but should not replace reading the textbook

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1 Chapter 7 Fiscal Policy These slides supplement the textbook, but should not replace reading the textbook

2 Who were the classical economists? A group of the 18 th and 19 th centuries, including Adam Smith known as the father of modern day economics 2

3 What did Adam Smith and the Classical Economists believe? The economy was always tending toward a full employment equilibrium and stable prices 3

4 What does laissez-faire mean? Leave well enough alone, let the economy correct problems itself 4

5 What happened in the Depression of 1921? Even though it was serious the government practiced laissez-faire and the economy recovered in a short period of time 5

6 What were policies of President Herbert Hoover in the early 1930s to combat the depression? public works projects raised taxes loans to failing firms relief programs 6

7 What were policies of President Franklin Roosevelt in 1933 to combat the depression? public works projects and social welfare programs raised taxes and wages loans to failing firms relief programs 7

8 According to Thomas Woods author of Meltdown, what was the result of these government programs? These programs prevented the economy from seeking its equilibrium of full employment and prolonged the depression 8

9 What is a fiscal policy? The manipulation of government purchases, transfer payments, taxes, and borrowing in order to positively influence the economy 9

10 How did Keynes influence fiscal policies? He argued that fiscal policies may be necessary to bring about full employment 10

11 How did World War II affect fiscal policies? It showed that a government stimulus package can work 11

12 What is the Employment Act of 1946? This is the official act that gave the government responsibility for promoting full employment and price stability 12

13 What are the four phases of the business cycle? trough recovery peak recession 13

14 What is a liquidity trap? A lack of borrowing keeps money bottled up in savings institutions 14

15 What is the Keynesian solution to a liquidity trap? Government borrows the money that consumers and business do not borrow 15

16 What does crowding out mean? During periods of full employment the government can borrow money that otherwise would be spent or invested 16

17 How does the government borrow money? It sells bonds (securities) to the Fed or in the Open Market 17

18 What is the current national debt? Just over 14 trillion dollars 18

19 What does monetizing the debt mean? The federal government sells bonds (securities) to the Fed and the Fed creates the money to buy the bonds 19

20 What can monetizing the debt lead to? A fall in the value of the dollar and inflation 20

21 What is a discretionary fiscal policy? Government policies that require ongoing decisions by policy makers 21

22 What are some examples of fiscal policies? Government purchases Transfer payments Taxes 22

23 What are automatic stabilizers? Structural features of government spending and taxation smooth out fluctuations in booms and busts 23

24 What are some examples of automatic stabilizers? Unemployment payments Welfare Other govt. programs 24

25 What is the point of Keynesian Economics? The economy could be stuck at equilibrium below the potential output for a prolonged period of time 25

26 What is an expansionary fiscal policy? An increase in government purchases, decrease in net taxes, or some combination of the two aimed at increasing aggregate demand 26

27 When would the government use expansionary fiscal policy? To stimulate the economy when unemployment is greater than the natural rate 27

28 What is an contractionary fiscal policy? A decrease in government purchases, increase in net taxes, or some combination of the two aimed at reducing aggregate demand 28

29 When would the government use contractionary fiscal policy? To slow down the economy when inflation is more than desired 29

30 What is the typical Keynesian policy during recessions? To use discretionary fiscal policies to stimulate the economy to a full employment equilibrium 30

31 What is the multiplier? Any change in the level of spending has a multiple effect on GDP 31

32 What is the balanced budget multiplier? Spending is multiplied because the government does not save any of the money it receives whereas consumes and business does 32

33 What is the accelerator? Any increase in spending can lead to an increase in secondary spending, for example, a new highway may lead to more restaurants, hotels, and gas stations 33

34 When does the accelerator have most impact on spending? During periods of full employment 34

35 How did World War II affect fiscal policies? It showed that a government stimulus package can work 35

36 What is MPC? The marginal propensity to consume (MPC) is a measure of how much consumers will spend out of any addition to their income 36

37 What is MPS? The marginal propensity to save (MPS) is a measure of how much consumers will save out of any addition to their income 37

38 If MPC is ¾, what is MPS? MPS would be ¼ because MPC + MPS = 1 38

39 What is the value of the multiplier? 1 / MPS 39

40 If MPC is ¾, what is the value of the multiplier? 1 / ¼ = 4 40

41 $ $75.00 $56.25 $42.19 original spent $ total money $

42 What effect does an increase in demand have on prices and output? The more steeply sloped the supply curve the greater impact on prices and the less impact on employment 42

43 Slightly sloped Supply Curve Price Level SRAS AD* AD Real GDP 43

44 Steeply sloped Supply Curve Price Level SRAS AD* AD Real GDP 44

45 What is a progressive income tax? A tax that levies a higher percentage on high income people than on low income people 45

46 How is a progressive income tax an automatic stabilizer? When the economy is in a slump incomes go down and people pay less taxes, during boom times incomes go up so taxes increase 46

47 What are transfer programs? Automatic stabilizers that aid with money people in need 47

48 What are examples of transfer programs? Unemployment benefits Welfare Food stamps Subsidized housing 48

49 What happens during economic contractions? Transfer payments increase 49

50 What will a cut in taxes do? It will stimulate both consumer demand and investment 50

51 How effective are fiscal polices? Automatic stabilizers are more effective than are discretionary fiscal policies 51

52 Should we rely on automatic stabilizers? The stronger and more effective the automatic stabilizers are, the less need there is for discretionary fiscal policies 52

53 How effective were fiscal policies during the stagflation of the 1970 s? Whatever we did to fight one problem we made the other problem worse 53

54 What is the natural rate of unemployment? The unemployment rate at which the economy is producing its potential GDP 54

55 What happens if the natural rate of unemployment is 6%, but the govt. thinks it s 5%? By stimulating the economy it will cause inflation over the long run 55

56 What are lag effects? Recognition lag Decision lag Action lag 56

57 Do lag effects influence discretionary fiscal polices? Yes, they weaken fiscal policies as a tool of economic stabilization 57

58 What is one s permanent income? Income that individuals expect to receive on average over the long term 58

59 Do consumers base their decisions on their permanent income or their short term income? Perceived long term income 59

60 What is one thing policy makers often overlook? How fiscal policies unintentionally affect individual incentive to work, save and invest 60

61 What is supply side economics? The belief that real GDP can be increased by giving people incentives to work 61

62 What was fiscal policy in the Reagan Administration of the 1980 s? Taxes were decreased to stimulate the economy by increasing aggregate supply 62

63 What effect does politics have on fiscal policies? There is always the danger that politicians can use discretionary fiscal policies to suit their short term political goals 63

64 Does the federal deficit affect fiscal policies? If we were to increase spending by borrowing, the national debt could become unmanageable 64

65 Watch video on the National Debt ay?p=national+debt&n=21&ei=utf- 8&js=1&fr2=tabweb&tnr=20&vid=

66 If we raise taxes, will tax revenues increase or decrease? If the increase in taxes sufficiently dampens spending and investments, tax revenues would decline 66

67 What is the Laffer Curve? A curve that shows that starting from zero an increase in taxes will raise revenue but beyond a point an increase will lower revenues 67

68 What is the difference between a stock and a flow way of thinking? An example of a stock situation would be an increase in government spending has no opportunity costs 68

69 If we spend a dollar do we pay for that dollar here and now? Yes, either by higher taxes, higher interest rates if we borrow the money, or more inflation if we create the money 69

70 END 70

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