Fiscal Policy Chapter 15.1

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.
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
Tax revenues

Low
revenues
b
a
0%
Low taxes
c
50%
Tax rate
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
Keynes Vs. Smith
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.
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.