Understanding FiscalPolicy

Objectives You may wish to callstudents’ attention to the objectivesin the Section Preview. The objec-tives are reflected in the main head-ings of the section.

Bellringer Ask students whetherthey or their families have ever madea budget. Ask how they make deci-sions about how much to spend onvarious items. Explain that in thissection they will learn that the gov-ernment must answer similar ques-tions when setting fiscal policy forthe entire country.

Vocabulary Builder As they read,have students create graphic organiz-ers to show relationships betweenthe key terms. Ask them to write ashort definition of each term in theirorganizers and to supply labels thatshow interrelationships. (For exam-ple, between the boxes for Office ofManagement and Budget and federalbudget, students might write thelabel prepares.)

Monetary and Fiscal Policy To build understand-ing of how public policy is expressed fiscally,have students complete two multi-flowchartgraphic organizers like the one at the right. Onecovering expansionary policies; the other cover-ing contractionary policies. Students shouldplace the expansionary (or contractionary) poli-cies in the outside boxes and the effect (encour-aging or slowing growth) in the center.

Section Reading Support Transparencies A tem-plate and the answers for this graphic organizercan be found in Chapter 15, Section 1 of theSection Reading Support Transparency System.

Graphing the Main Idea

ChaptChapter er 1155 •• Section Section 11

TThe word fiscal comes from the Latinword fisc, which means “basket” or

“bag.” Over time, the word came to belinked with a bag of money. Specifically, itmeant the “bag,” or pool, of money heldby the government. In Chapter 14, youread about how the government collectsmoney, primarily through taxes, and howthe government spends its money on a widevariety of programs. In this section you willread about fiscal policy. Fiscal policy is theuse of government spending and revenuecollection to influence the economy.

Fiscal Policy as a ToolAs you learned in Chapter 14, the federalgovernment takes in and spends hugeamounts of money. The federal govern-ment spends about $250 million everyhour, $6 billion every day, and about $2.3trillion a year. The tremendous flow of cashinto and out of the economy has a largeimpact on aggregate demand and supply inthe economy.

Fiscal policies are used to achieveeconomic growth, full employment, andprice stability. Fiscal policy decisions—howmuch to spend and how much to tax—areamong the most important decisions the

federal government makes. These decisionsare made each year during the creation ofthe federal budget.

The Federal BudgetThe federal budget is a written documentindicating the amount of money thegovernment expects to receive for a certainyear and authorizing the amount the

Understanding Fiscal Policy

Section FocusThe federal government takes inmoney for the budget throughtaxation and borrowing. Thedecisions the government makesabout taxing and spending can havea powerful impact on the overalleconomy.

Key TermsObjectivesAfter studying this section you will be able to:1. Describe how the government uses fiscal

policy as a tool for achieving its economicgoals.

2. Explain how the government creates thefederal budget.

3. Analyze the impact of fiscal policy decisionson the economy.

4. Identify the limits of fiscal policy.

Preview

fiscal policyfederal budgetfiscal yearOffice of Management

and Budget (OMB)Congressional Budget

Office (CBO)appropriations billexpansionary policiescontractionary policies

� Federal budget costs include Transportation Security Administrationworkers who screen airline passengers and luggage for security threats.

fiscal policy the use ofgovernment spendingand revenue collectionto influence theeconomy

federal budget a planfor the federalgovernment’s revenuesand spending for thecoming year

B U I L D I NGB U I L D I NG

K E Y CONCE PTSK E Y CONCE PTS

Lesson PlanTeaching the Main Concepts

1. Focus Point out to students that thegovernment’s budget and a commonhousehold budget are similar but thatthe size of the country and its govern-ment make the budgeting processmuch more complex. Ask students toidentify other ways in which the twobudgets differ.2. Instruct Define fiscal policy andexplain its relationship to the federalbudget. Explain how the federal budgetis created. Distinguish between policiesdesigned to expand and to contract theeconomy, and explain the purpose ofeach. Finally, identify the limitations offiscal policy.3. Close/Reteach To check students’understanding of the effects of fiscalpolicy on the economy, have them pro-vide oral summaries of the graphics onpp. 389–390.

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Monetary and Fiscal Policy One of the key con-cepts in this section is the use of a budget. The textcompares family budgets to the federal budget.These comparisons are helpful, but students needto comprehend the much greater complexity of thefederal budgeting process.

Briefly summarize a typical family budgetingprocess. Then ask students to create a Venn dia-gram that shows the similarities and differencesbetween a family budget and the federal budget.

Econ 101: Key Concepts Made EasyEcon 101: Key Concepts Made Easy$

Guided Reading and ReviewUnit 6 folder, p. 15 asks students toidentify the main ideas of the sectionand to define or identify key terms.

Have students write a letter to a for-eign friend who has asked what fiscalpolicy is, how it affects the economy,and how the federal budget is relatedto fiscal policy. Students should sum-marize the budget process itself as wellas the role of each branch of govern-ment in creating a budget. Encouragestudents to use language and sentencestructure that would be easily under-stood by someone who is not a nativespeaker of English.

Transparency Resource PackageEconomics Concepts, 15A: Fiscal

Policy

Have students locate a copy of thepublication “A Citizen’s Guide to theFederal Budget,” published by theGovernment Printing Office. Ask stu-dents to examine the guide, especiallythe charts and graphs. Have themchoose a graphic that they think is par-ticularly clear or informative and shareit with the class. Explain to studentsthat this will help all students under-stand important aspects of the budget.GT

Take It to the NETThis publication is available on-line.Have students use the links provided inthe Economics: Principles in Action seg-ment in the Social Studies area at thefollowing Web site: www.phschool.com

Answer to . . .Building Key Concepts Federalagencies send requests for money tothe Office of Management andBudget.

government can spend that year. Thefederal budget is just a plan to pay for thefederal government’s expenditures. Muchlike a family’s budget, it lists expectedincome and shows exactly how the moneywill be spent.

The federal government prepares a newbudget for each fiscal year. A fiscal year is atwelve-month period that is not necessarilythe same as the January-to-Decembercalendar year. The federal government usesa fiscal year that runs from October 1through September 30.

The federal budget takes about 18months to prepare. During this time,citizens, Congress, and the President debatethe government’s spending priorities. Thereare four basic steps in the federal budgetprocess.

Spending Proposals The federal budget must fund many officesand agencies in the federal government,

and Congress cannot decide all of theirneeds. Before the budget can be puttogether, each federal agency writes adetailed estimate of how much it expects tospend in the coming fiscal year.

These spending proposals are sent to aspecial unit of the executive branch, theOffice of Management and Budget (OMB). TheOMB is part of the Executive Office of thePresident. As its name suggests, the OMB isresponsible for managing the federalgovernment’s budget. Its most importantjob is to prepare the federal budget.

In the Executive BranchThe OMB holds several meetings to reviewthe Federal agencies’ spending proposals.Representatives from the agencies mustexplain their spending proposals to theOMB and convince the OMB to give themas much money as they have asked for.Usually, OMB gives each agency less thanthey say they need.

The OMB then works with the Presi-dent’s staff to combine all of the individualagency budgets into a single budgetdocument. This document gives the Presi-dent’s overall spending plan for the comingfiscal year. The President presents thebudget to Congress in January or February.

In CongressThe President’s budget is only a startingpoint, and the number of changes Congressmakes depends on the relationship betweenthe President and Congress. Congress care-fully considers, debates, and modifies thePresident’s proposed budget. For help,members of Congress rely on the assistanceof the Congressional Budget Office (CBO).Created in 1974, the CBO gives Congressindependent economic data to help with itsdecisions.

Much of the work done by Congress—the House of Representatives and theSenate—is done by small committees.Working at the same time in differenthouses of Congress, committees in theHouse and Senate analyze the budget andhold hearings at which agency officials andothers can speak out about the budget. The

Figure 15.1 Creating the Federal Budget Figure 15.1 Creating the Federal Budget

Federal agencies send requests for money to the Office of Management and Budget.

The Office of Management and Budget works with the President to create a budget. In January or February, the President sends this budget to Congress.

Congress makes changes to the budget and sends this new budget to the President.

The President vetoes the budget. If Congress cannot get a majority to override the President’s veto, Congress and the President must work together to create a new, compromise, budget.

The President signs the budget into law.

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Congress and the White House work together over thecourse of the year to put together a federal budget. Government Who takes the first step in the budgetprocess?

fiscal year a twelve-month period that canbegin on any date

Office of Managementand Budget (OMB)government office thatmanages the federalbudget

Congressional BudgetOffice (CBO)government agencythat provideseconomic data toCongress

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ChaptChapter er 1155 •• Section Section 11

Answer to . . .Building Key Concepts Governmentspending increases aggregate sup-ply, encouraging the economy toexpand.

Consider these suggestions to take advantage ofextended class time:

� Extend the first activity on p. 388 by havingeach student exchange letters with a partner. Eachpartner should read the other’s letter and thenwrite a letter back asking for more clarificationwhere it is needed. The writer of each original let-ter should then make these clarifications andresubmit the letter.

� Show the Economics Video Library segment“New Economic Era?” about America’s strongeconomic growth, unaccompanied by inflation.The phenomenon has caused economists to reex-amine whether old patterns still hold true. Afterstudents view the segment, provide copies of sev-eral articles that reflect this debate, and hold a dis-cussion on economic growth and fiscal policy.

Block Scheduling StrategiesBlock Scheduling Strategies

Ask students to examine the sectionand the flowchart on p. 388. Thenask the question: “Who are the mainplayers in the budgetary process?”(federal agencies, the Office ofManagement and Budget, thePresident, Congress) Have studentslocate more specific informationabout the role of each arm of gov-ernment in the budgetary process.Finally, ask them to write out a list ofresponsibilities for each of thesegroups.

Transparency Resource PackageEconomics Concepts, 15B:

Wrestling with the Budget

Have students print out several yearsof federal government budgets inmajor categories from the StatisticalAbstract of the United States or fromanother Internet site. Compare theincreases in spending by category,and discuss reasons for the differencein rates of increase or decrease. SN

House Budget Committee and SenateBudget Committee combine their work topropose one initial budget resolution,which must be adopted by May 15 of theyear. This resolution is not intended to befinal, but gives initial estimates for revenueand spending to guide the legislators asthey continue working on the budget.

Then, in early September, the BudgetCommittees for each house of Congresspropose a second budget resolution thatsets binding spending limits. Congress mustpass this resolution by September 15, afterwhich Congress cannot pass any new billsthat would spend more money than thebudget resolution allows.

Finally, the Appropriations Committeesfor each house submit bills to authorizespecific spending. By this time, the newfiscal year is about to start and Congressfaces pressure to get these appropriations billsadopted and submitted to the Presidentquickly before the previous year’s fundingends on September 30. If Congress cannotfinish in time, it must pass short-termemergency spending legislation known as“stop-gap funding” to keep the governmentrunning. If Congress and the Presidentcannot even agree on temporary funding,the government “shuts down” and all butthe most essential federal offices will close.

In the White House Congress sends the appropriations bills tothe President, who can sign them into law.If he vetoes any of these bills, Congressmust either come up with enough votes tooverride the veto—usually, this is impos-sible—or work with the President to writean appropriations bill on which both sidescan agree. Once that is completed, thePresident signs the new budget into law.

Fiscal Policy and the EconomyGovernment officials who take part in thebudget process debate how much shouldbe spent on specific programs such asdefense, education, and scientific research.

They also consider how much should bespent in total. The total level of govern-ment spending can be changed to helpincrease or decrease the output of theeconomy. Similarly, taxes can be raised orlowered to help increase or decrease theoutput of the economy.

Fiscal policies that try to increase outputare known as expansionary policies. Fiscalpolicies intended to decrease output arecalled contractionary policies. By carefullychoosing to follow expansionary orcontractionary fiscal policies, the federalgovernment tries to make the economy runas smoothly as possible.

Expansionary Fiscal PoliciesGovernments use expansionary fiscalpolicies to raise the level of output in theeconomy. That is, they use expansionarypolicies to encourage growth, either whenthe economy is in a recession or to try toprevent a recession. Recall from Chapter 12that a recession is the part of the business

Pric

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Total output in the economyLow output

Lowprices

High output

Figure 15.2 Effects of Expansionary Fiscal PolicyFigure 15.2 Effects of Expansionary Fiscal Policy

Highprices Aggregate

supply

Higher output,higher prices

Aggregatedemand with highergovernmentspending

Lower output,lower prices

Originalaggregatedemand

Expansionary fiscal policy helps the economy by increasingaggregate demand and output. Supply and Demand How do increases in governmentspending affect aggregate supply?

appropriations bill abill that sets moneyaside for specificspending

expansionary policiesfiscal policies, likehigher spending andtax cuts, thatencourage economicgrowth

contractionary policiesfiscal policies, likelower spending andhigher taxes, thatreduce economicgrowth

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(Enrichment) To help students under-stand a real-life issue in fiscal policy,have them research the capital-gainstax. Capital gains are made when sell-ing assets, especially shares of stock.Have students investigate argumentsfor and against cutting the tax. Thenhave them write an essay explainingwhich side they support and whetherthat policy is expansionary or con-tractionary.

Organize students into groups of three.Ask each group to create three eco-nomic scenarios that involve such fac-tors as recession, unemployment, orinflation. (Encourage students toexamine the headings titled“Expansionary Fiscal Policies” and“Contractionary Fiscal Policies” tofind ideas for their scenarios.) Thenhave groups exchange scenarios andsuggest specific expansionary or con-tractionary fiscal policies to deal witheach situation. Groups should be ableto explain why they suggested theremedies they did.

Learning Styles ActivityLearning Styles Lesson Plans folder, p. 35 asks students to compose lettersto representatives in Congress askingthat a budget allocation be created orretained for a specific need or project.

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Answer to . . .Building Key Concepts Like govern-ment spending, tax cuts provideconsumers with more money tospend and businesses with moreprofits, all of which increasedemand, prices, and output.

Have students read the section titled “Contractionary Fiscal Policies” and then answerthe question below.According to the text, what occurs—or may occur—when the government pursues acontractionary economic policy?

A Economic growth may be reduced.

B Taxes may be raised.

C Government spending may be reduced.

D all of the above

Preparing for Standardized TestsPreparing for Standardized Tests��

cycle that occurs when output declines fortwo quarters, or three-month periods, in arow. Expansionary fiscal policies fall intoeither or both of two categories: increasinggovernment spending and cutting taxes.

Increasing Government SpendingIf the federal government increases itsspending or buys more goods and services,it triggers a chain of events that raisesoutput and creates jobs. Governmentspending increases aggregate demand,which causes prices to rise. (See Figure 15.2.)According to the law of supply, higherprices encourage suppliers of goods andservices to produce more. To do this, firmswill hire more workers. In short, an increasein demand will lead to lower unemploy-ment and to an increase in output, as shownin Figure 15.3. The economy will beencouraged to expand.

Cutting TaxesTax cuts work much like higher govern-ment spending to encourage the economyto expand. If the federal government cutstaxes, individuals have more money to

spend, and businesses keep more of theirprofits. Consumers will have more moneyto spend on goods and services, and firmswill have more money to spend on land,labor, and capital. These actions willincrease demand, prices, and output.

Contractionary Fiscal PoliciesAt some stages in the business cycle, thegovernment may choose contractionaryfiscal policies. Contractionary fiscal policiestry to decrease aggregate demand, and bydecreasing demand, reduce the growth ofeconomic output. If contractionary fiscalpolicies are strong enough, they may slowthe growth of output to zero, or even leadto a fall in GDP.

The government sometimes tries to slowdown the economy because fast-growingdemand can exceed supply. When demandexceeds supply, producers must choosebetween raising output and raising prices.If producers cannot expand productionenough, they will raise their prices, whichleads to high inflation. As you read inChapter 12, inflation is an increase inprices over time. Inflation cuts intoconsumers’ purchasing power and discour-ages economic growth and stability. Fiscalpolicies aimed at slowing the growth oftotal output generally fall into either orboth of two categories: decreasing govern-ment spending and raising taxes.

Decreasing Government SpendingIf the federal government spends less, orbuys fewer goods and services, it triggers achain of events that may lead to slowerGDP growth. A decrease in governmentspending leads to a decrease in aggregatedemand because the government is buyingless than before. Decreased demand tendsto cause lower prices. According to the lawof supply, lower prices encourage suppliersto cut their production and possibly fireworkers. Lower production lowers thegrowth rate of the economy and may evenreduce GDP.

Figure 15.3 Flowchart of Effects ofExpansionary Fiscal PolicyFigure 15.3 Flowchart of Effects ofExpansionary Fiscal Policy

To expand the economy, the government buys more goods and services.

Companies that sell goods to the government earn profits, which they use to pay their workers and investors more and to hire new workers.

Workers and investors have more money and spend more in shops and restaurants.

Shops and restaurants buy more goods and hire more workers to meet their needs.

In the short term, government spending leads to more jobs and more output.

The goal ofexpansionary fiscalpolicy is to addmoney to theeconomy. Government Howmight cutting taxeshave similar effectsto those shown in thechart?

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You may wish to have students addthe following to their portfolios. Thebattle over the federal budget is ayear-round process, and thereforethe flow of news on the budget isusually continuous. For a period ofseveral weeks, ask students to readdaily newspapers for articles on thebudgetary process. Have studentsclip the articles or photocopy themand add them to their portfolios. Atthe end of this period, ask studentsto write a short summary of the arti-cles they found. GT

Economics Assessment RubricEconomics Assessment Rubrics folder,pp. 6–7 provides sample evaluationmaterials for a writing assignment.

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ChaptChapter er 1155 •• Section Section 11

BackgroundGlobal ConnectionsGlobal ConnectionsAn often surprising part of the politi-cal budgeting process is called“pork barrel legislation.” This refersto spending packages members ofCongress attach to bills; packagesthat aid only their own constituents.The extra funding generally hasnothing to do with the main purposeof the bill. For example, in the springof 1999, President Clinton made a $6billion emergency spending requestto aid war refugees in Kosovo andtornado victims in the midwesternUnited States. By the time Congresswas ready to vote on it, the bill hadexpanded to $14.7 billion, including$3 million to aid commercial reindeerherders in Alaska and a permit toopen a controversial gold mine on amountain in Washington State.

Monetary and Fiscal Policy The notion of contrac-tionary fiscal policies may be difficult for somestudents to comprehend. Tell students to think ofthe economy as a person who has gained a fewpounds and is unable to fit into his or her oldclothing. If the economy’s demand is too high (theeconomic equivalent of an increased appetite),inflation (like unwanted weight) may result.

By reducing spending, the government puts theeconomy on a diet. By raising taxes, the govern-ment makes the economy exercise a bit more, withthe burned calories flowing into government cof-fers. Ask students to apply this example to expan-sionary fiscal policies either orally or in writing.

Econ 101: Key Concepts Made EasyEcon 101: Key Concepts Made Easy$Answer to . . . Building Key Concepts Lower gov-ernment spending leads to adecrease in aggregate demand,causing lower output, possiblylower prices, and the potential forrecession. If the economy has beenexpanding too quickly, the marketwill move toward equilibrium.

This chain of events is the exact oppositeof what happens when the governmentincreases spending. The government usesthe same tools to try to influence theeconomy in both cases, but in differentways, and with very different goals.

Increasing TaxesWhen the federal government raises taxes,individuals have less money to spend ongoods and services or to save for the future.Firms keep less of their profits and decreasetheir spending on land, labor, and capital.As a result of these decreases in demand,prices tend to fall. Producers of goods andsuppliers of services tend to cut production.This slows the growth of GDP.

Limits of Fiscal PolicyOn paper, fiscal policies look like powerfultools that can keep the economy in perfectbalance. In reality, fiscal policies can beclumsy and difficult to put into practice.

Difficulty of Changing Spending LevelsIncreasing or decreasing the amount offederal spending is not an easy task. As youread in Chapter 14, many of the spendingcategories in the federal budget are entitle-ments that are fixed by law. Nearly 60percent of the federal budget is set aside forprograms such as Medicaid, SocialSecurity, and veterans’ benefits beforeCongress even begins the budget process.The government cannot change spendingfor entitlements under current law. As aresult, significant changes in federalspending generally must come from thesmall part of the federal budget thatincludes discretionary spending. This givesthe government less leeway for increasingor lowering spending.

Predicting the FutureGovernments use fiscal policies to preventbig changes in the level of GDP. Despite thestatistics, however, it is difficult to knowthe current state of the economy. As youread in Chapter 12, no one can predict howquickly the business cycle will move from

one stage to the next, nor can anyoneidentify exactly where the economy is atany specific point in the cycle. Economistsoften disagree about the meaning of statis-tics, whether they show the economy is ingood condition or ready for a recession.

Predicting future economic performanceis even more difficult. As a result,lawmakers may put off making changes infiscal policy until they know more abouthow the economy is performing. By then, itmay be too late to act.

In addition, when lawmakers put fiscalpolicies in place, they base their decisionspartly on the past behaviors of individuals.It is risky to assume that people will, forexample, respond the same way to a taxcut in the future as they have in the past.

Delayed ResultsAlthough changes in fiscal policy affect theeconomy, changes take time. Once govern-ment officials decide when and how tochange fiscal policy, they have to put thesechanges into effect within the federalbudget, which itself takes over a year to

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Total output in the economyLow output

Lowprices

High output

Figure 15.4 Effects of Contractionary Fiscal PolicyFigure 15.4 Effects of Contractionary Fiscal Policy

Highprices Aggregate

supply

Higher output,higher prices

OriginalaggregatedemandLower output,

lower prices

Aggregatedemand withlower governmentspending

By cutting spending, the government can sloweconomic growth.Supply and Demand How does lower governmentspending affect equilibrium?

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(Reteaching) To help students under-stand the limits of fiscal policy, askthem to contribute to a list of the rea-sons why fiscal policies are difficult toput into practice. As each reason issuggested, challenge students to namea real-life example of this reason. Forexample, for difficulty of changingspending levels, they may recallmandatory spending information fromChapter 14.

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BackgroundCareers in EconomicsCareers in EconomicsFor those interested in combining aninterest in economics and a talent forwriting, journalism may be an excel-lent career choice. Journalists whohave a thorough understanding ofeconomics will always be in demandbecause of their ability to translatethe intricacies of fiscal policy and theeconomic ideas behind them into lan-guage that can be understood by thetypical newspaper reader.

develop. Finally, they have to wait for thechange in spending or taxing to affect theeconomy.

By the time the policy takes effect, theeconomy might be moving in the oppositedirection. The government could proposemassive public spending on highways in themiddle of a recession, only to have theeconomy recover before constructionbegins. In these cases, fiscal policy wouldonly add to the new trend, instead ofcorrecting the original problem. If thegovernment continued to spend lots ofmoney on highways in the middle of arecovery, it could lead to high inflation anda labor shortage.

Political PressuresThe President and members of Congress,who develop the federal budget and thefederal government’s fiscal policies, areelected officials. If they wish to bereelected, they must make decisions thatbenefit the people who elect them, notnecessarily decisions that are good for theoverall economy.

For example, government officials havean incentive to practice expansionary fiscalpolicies by increasing government spendingand lowering taxes. These actions areusually popular with voters, although inSection 3 you will read about why somepeople disapprove of governmentspending. Government spending benefitsthe firms that receive government contractsand the individuals who receive directpayments from the government. Lowertaxes leave more disposable income inpeople’s pockets.

On the other hand, contractionary fiscalpolicies that decrease government spendingor raise taxes are often unpopular. Firmsand individuals that expect income from thegovernment are not happy when the incomeis reduced or cut off. No one likes to payhigher taxes, unless the tax revenue is spenton a specific, highly valued good or service.

Coordinating Fiscal PolicyFor fiscal policies to be effective, variousbranches and levels of government mustplan and work together. This is very diffi-cult to do. For example, if the federalgovernment is pursuing contractionarypolicies, ideally state and local govern-ments should pursue consistent fiscalpolicies. Yet, state and local governmentsmay be pursuing different goals for fiscalpolicy than the federal government.

For example, after the federal govern-ment cut income taxes in 2001 and 2003,many state and local governments raisedincome and property taxes to close budgetdeficits and avoid deep spending cuts. Thefederal goverment was willing to cut taxesand run a deficit in poor economic times,but most state and local goverments werelegally forbidden to do so.

Experimenting in Japan Japan used expansionary fiscalpolicies in the 1990s to try to end an economic slump. When real estate pricesand stock prices decreased sharply in Japan in the early 1990s, investors,businesses, and banks lost much of their wealth. Consumers and businessesspent less, and banks could not afford to lend money for new investment, sothe economy suffered. The Japanese government tried to increase demand byspending money on new roads, government-sponsored loans, and tax cuts.Between 1992 and 1999, the government passed nine major bills spending atotal of $1.1 trillion, or nearly $90,000 for every man, woman, and child in Japan.The plan failed to revive the economy and burdened the government withenormous debts. By 2004, government debt had reached 173% of GDP but theeconomy was still struggling.

Global Connections

� Cutting govern-ment spending isdifficult becausesome voters willobject to cuts thatimpact their interests.

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Guide to the EssentialsChapter 15, Section 1, p. 63 pro-vides support for students who needadditional review of the section con-tent. Spanish support is available inthe Spanish edition of the guide onp. 63.

Quiz Unit 6 folder, p. 16 includesquestions to check students’ under-standing of Section 1 content.

Presentation Pro CD-ROMQuiz provides multiple-choice

questions to check students’ under-standing of Section 1 content.

Answers to . . .

Section 1 AssessmentSection 1 Assessment1. Fiscal policy is government use of

taxing and spending to stabilize theeconomy. The federal budget is therevenue and spending plan basedon fiscal policy decisions. The twoare related because the federalbudget expresses the government’scurrent fiscal policy.

2. The federal fiscal year begins October 1.

3. The Office of Management andBudget (OMB) is the part of theExecutive Office of the Presidentthat prepares the federal budgetbased on spending proposalsreceived from federal agencies.

4. Two expansionary policies areincreasing government spendingand cutting taxes.

5. A tax cut makes more money avail-able to consumers to spend ongoods and services. Firms keepmore profits that they can reinvestin labor, land, and capital. All ofthese factors increase GDP in theshort run.

6. (a) Students may suggest raisingtaxes to slow consumer and pro-ducer spending, curbing both infla-tion and economic growth. (b)Students may suggest cutting taxes,allowing firms to reinvest in morelabor and allowing consumers topurchase more goods and services.Both will raise GDP.

7. Some students may suggest neithertype of policy because consumerconfidence was moderate. Somemay suggest contractionary policiesbecause confidence was rising.

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ChaptChapter er 1155 •• Section Section 11Businesspeople, politicians, and econo-

mists often disagree about how well theeconomy is performing, and what the goalsof the fiscal policy should be. Also,different regions of the economy can expe-rience very different conditions. Californiaand Hawaii may have high unemploymentwhile Nebraska and Massachusetts facerising prices and a labor shortage.

In addition, in order for the federalgovernment’s fiscal policy to be effective, itmust also be coordinated with themonetary policies of the Federal Reserve.You’ll read more about monetary policy inthe next chapter.

Even when all of these obstacles areovercome, fiscal policy faces still anotherlimitation. The short-term effects of fiscalpolicy can be different from the long-termeffects. A tax cut or increased governmentspending will give a temporary boost toeconomic production and to employment.However, as the economy returns to fullemployment, high levels of governmentspending combined with market spendingwill lead to increased inflation as theeconomy overheats.

Similarly, an increase in taxes or adecrease in government spending may“cool” the economy and lead to a reces-

sion. However, in the long run, reducedgovernment spending will allow othertypes of spending to increase withoutrisking higher inflation. If there is moreprivate investment spending, this couldlead to higher economic growth in the longrun. In this way, slow growth or even reces-sion in the short term can lead to prosperityand more jobs in the future.

Section 1 Assessment

Key Terms and Main Ideas1. Explain fiscal policy and how it relates to the federal

budget.2. When does the federal government’s fiscal year begin?3. What role does the Office of Management and Budget

(OMB) play in creating the federal budget? 4. What are two types of expansionary policies?

Applying Economic Concepts5. Critical Thinking Explain how a tax cut can lead to a

higher GDP in the short run.6. Try This Which fiscal policy strategy do you think

policymakers would use in each of these scenarios?Explain your answers. (a) Inflation is rising, and real GDPis up by 4 percent. (b) GDP is down, and the unemploy-ment rate has increased to 10 percent.

7. Using the Databank The Consumer Confidence Indexmeasures how optimistic American consumers are thatthe economy will do well. The graph on page 539 of theDatabank measures consumer confidence in recentyears. If you had been a policymaker in 2004, would youhave recommended expansionary or contractionaryfiscal policies? Explain your answer.

� New community-built pools, like thisone in California,have an economicimpact on the locallevel by providingjobs.

PHSchool.com

For: Simulation ActivityVisit: PHSchool.comWeb Code: mnd-6151

Progress Monitoring OnlineFor: Self-quiz with vocabulary practiceWeb Code: mna-6155

Typing in the Web Codewhen prompted will bring students directlyto detailed instructions for this activity.

Progress Monitoring OnlineFor additional assessment, have students accessProgress Monitoring Online at Web Code: mna-6155