Fiscal Policy

*The government has three roles in the economy:

TAXATION,SPENDING,

& REGULATION

Historically…Initially, the US government started with a _________________________

approach to business. However, after the

______________________________________, it was clear that the economy

needed some guidance.

LAISSEZ FAIRE

GREAT DEPRESSION

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So..After _______________, the government decided they needed to take a

_________________________ in the economy to regulate:

•UNEMPLOYMENT•BUSINESS CYCLES•INFLATION•COST OF MONEY

WWII

PROACTIVE ROLE

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By using a mixture of both ___________________________ and

_______________________ policies, governments are able to,

in a sense, guide the economy,

preventing major economic turmoil.

Fiscal

Monetary

What is it?Fiscal policy is the way governments adjust levels

of ___________________ in order to ___________________ and

_____________________ a nation's economy. It is the sister strategy to

____________________________ with which a ___________________________ influences a

nation's money supply. These two policies are used to help guide a country to meet its

_______________________________.

SPENDINGMONITOR

INFLUENCE

MONETARY POLICYCENTRAL BANK

ECONOMIC GOALS

How does it work?It is based on the theories of British economist

____________________________. _________________________, states that

governments can influence ____________________________________ levels by raising or lowering ____________________ and

_________________________. This CAN curb ___________________ (generally considered to be healthy when at a level between 2-3%), decrease

______________________ and maintain the value of ___________.

JOHN MAYNARD KEYNESKEYNESIAN ECONOMICS

MACROECONOMIC PRODUCTIVITYTAX LEVELS

PUBLIC SPENDINGINFLATION

UNEMPLOYMENTMONEY

AGGREGATE DEMAND:The sum of all demand in the economy

DISCRETIONARY FISCAL POLICY:Actions taken by the government by choice to correct economic instability; Congress must enact legislation in order for these policies to be implemented. (Similar to discretionary spending)

EXPANSIONARY FISCAL POLICY:Plan to increase aggregate demand and stimulate a weak economy

CONTRACTIONARY FISCAL POLICY:

Plan to reduce aggregate demand and slow down an inflationary (too-rapidly expanding) economy

AUTOMATIC STABILIZERS:Features of fiscal policy that work automatically to stabilize the economy

PUBLIC TRANSFER PAYMENTS

PROGRESSIVE INCOME TAXES

As income increases, so do taxes allowing it to be an automatic stabilizer

Unemployment compensation, food stamps, welfare, etc.; when people receive these benefits, they gain income to spend so that recession is less severe on the individual/family. In a weak economy, more people qualify for these benefits; in a strong economy, less qualify

LIMITATIONS OF FISCAL POLICY:1. It follows economic conditions and passing legislation takes

time.2. It should follow the business cycle to balance out peaks and

troughs, but it is tough to predict.3. Rational Expectation Theory-people and businesses expect

fiscal policy to have certain outcomes. When they react to protect their interests, they may limit the effectiveness of the policy.

4. Political issues. (Council of Economic Advisers-advises president on fiscal policy, but they do not always follow because of political pressure.)

5. Regional issues.

DEMAND-SIDE ECONOMICS:FISCAL POLICY TO STIMULATE AGGREGATE

DEMAND– KEYNESIAN ECONOMICS

What was Keynes first

revolutionary idea?

He defined AGGREGATE DEMAND as the sum of investment,

consumer spending, government spending, and net exports.

What did he propose the

British government do in 1929?

He proposed they spend money on public works

projects to create jobs and ease unemployment.

What made Keynes

question classical

economics?

The 1920’s going into the Great Depression and the cycle of

demand falls, businesses produced less leading to layoffs, consumers had less money which

led to falling demand…

Name two of his books:

A Treatise on Money (1930)The General Theory of

Employment, Interest, and Money (1936)

Keynes advocated increased government spending and

decreased taxation to end recessions.

INCREASED GOVERNMENT

SPENDING

CREATES JOBS

INCREASES INCOME

Keynes advocated increased government spending and

decreased taxation to end recessions.

DECREASED TAXATION

CONSUMERS SPEND MORE

BUSINESSES INVEST MORE

Historically, when did this work?WWII

However, this does not always work because excessive

GOVERNMENT or

CONSUMER spending can lead to

INFLATION!!!

Cutting government spending is not always easy because people become

RELIANT on these programs. Just like increasing taxes is not easy because politicians will

often do what will WILL GET THEM RE-ELECTED

as opposed toWHAT IS BEST FOR THE COUNTRY

During periods of STAGFLATION

(slow economic growth with high unemployment and inflation)

demand-side policies seem to be INEFFECTIVE

SUPPLY-SIDE FISCAL POLICY:Focuses on cutting the cost of production to

encourage producers to supply more.

SUPPLY-SIDE ECONOMISTS FAVOR:•CUTTING TAXES ON INDIVIDUAL AND CORPORATE INCOME•CUTTING IN THE HIGHER TAX BRACKETS GIVES MORE MONEY

TO THOSE MOST LIKELY TO INVEST IN BUSINESS •SPENDING CUTS-THE LESS THE GOVERNMENT SPENDS

THE LESS TAXES NEED TO BE COLLECTED•DECREASE GOVERNMENT REGULATION BECAUSE THESE ADD

TO THE COSTS OF PRODUCTION

Laffer Curve

Illustrates how tax cuts affect tax revenues and economic growth.Tax revenues increase as tax rates increase to a certain point.

After that point, higher taxes actually lead to decrease tax revenue.WHY?

Too high of taxes could actually discourage people from working, investing, and spending.

PROVING LAFFER’S THEORY:Legislation passed in the 1980’s

CUT federal income tax rates substantially (top tax bracket from 70% to around

30%), however revenue collected from income tax

INCREASEDabout 13%.

DISPROVING LAFFER’S THEORY:1. With lower taxes people should work

more as some did. However, some found they brought home the same

amount of income from before the tax cuts by working less.

2. Lower tax rates should increase savings and investments, but savings declined

during the 1980’s.