Fiscal Policy Chapter 15.1 Don t always follow the advice of following your dreams because it s hard to get a job as a dragonfly.
Budget: a list of all your income and a list of all of your expenses and trying to make them balance Federal budget: a plan for the federal government s revenues and spending for the coming year Fiscal Policy means to influence the economy through the use of government spending and taxation
Contractionary Fiscal Policy (The BRAKE) Laws that reduce inflation, decrease GDP (Close a Inflationary Gap) Decrease Government Spending Tax Increases Combinations of the Two Expansionary Fiscal Policy (The GAS) Laws that reduce unemployment and increase GDP (Close a Recessionary Gap) Increase Government Spending Decrease Taxes on consumers Combinations of the Two How much should the Government Spend? 3
Expansionary Policy The goal is to encourage economic growth by increasing spending and tax cuts. This is done during a recession or trying to prevent one.
Government Spending Government spending increases aggregate demand which raises prices, which encourages suppliers to make more products. Therefore more workers are hired and unemployment decreases.
Cutting taxes Cutting taxes allows individuals and business to have more money to spend.
Contractionary Policy Contractionary policy tries to reduce growth by lowering spending and raising taxes During a time where demand is higher than supply, it would cause inflation. So the government might want to slow the economy down.
Limits of Fiscal Policy 1. Difficulty of changing spending levels. It takes time for laws to pass. Once the budget is established, it s not easily changed. 2. Predicting the future The business cycle is hard to predict where it is at. 3. Delayed results The government is a little slow to react and it takes time to see what happens
Limits of Fiscal Policy (cont.) 4. Political pressures No one likes higher taxes even if they are needed. 5. Coordinating Fiscal Policy For example: the fed might lower taxes, but the local government might raise taxes thinking that there is extra money available.
Ch 15.2 Fiscal Policy Options Classical economics: people act in their own self interest which will create equilibrium (prices will increase or decrease causing supply and demand to reach equilibrium). *Adam Smith, David Ricardo, and Thomas Malthus are economist who support this theory.
The Money Multiplier The multiplier effect in fiscal policy is the idea that every one dollar change in fiscal policy creates a greater than one dollar change in economic activity. Example: if the govt. spends one dollar on a salary, the one dollar will turn into $5 because that person spends it at a business, which then has to buy more from another business, etc.
Tax revenues Supply Side Economics Supply-side economics stresses the influence of taxation on the economy. Supplysiders believe that taxes have a strong, negative influence on output. The Laffer curve shows how both high and low tax revenues can produce the same tax revenues. Laffer Curve High revenues Low revenues a 0% Low taxes b 50% Tax rate c 100% High taxes
Classical Economics The market can take care of itself. The invisible hand guides the economy and brings about market equilibrium. But the Great Depression challenged that notion.
John Maynard Keynes John Maynard Keynes (1883 1946) Sometimes called the father of macroeconomics. He believed that the government could and must help guide the economy through the use of fiscal and monetary policy. Candy Canes Delicious treat Rhymes with Keynes
Tale of the Tape: J. M. Keynes 5 11 210 lbs. Died 1946 Strengths: Investing money, debating & writing poetry with weird rhymes Belief: Need for government intervention. Adam Smith 6 1 195 lbs. Died 1790 Strengths: Wearing wigs, telling unfunny jokes & writing books. Belief: Let the economy do its own thing; no regulations or help needed. Keynes Vs. Smith
Classical Versus Keynes Classical economists believed that there were strong forces that would push the economy back into equilibrium after shocks that had caused high levels of unemployment. John Maynard Keynes, however, suggested that this did not occur because there was a failure of coordination in the economy. Because there was insufficient demand for goods, factories produced less and employed fewer people. With fewer people employed, there were fewer consumers, and demand fell still further. Keynes believed that the government had to step in and create the needed demand.