Download Fiscal Policy - APMacroecononomics

FISCAL POLICY
• Government efforts to promote full
employment and price stability by
changing government spending (G)
and/or taxes (T).
• Congress only…
TWO KINDS OF FISCAL POLICY
• Expansionary policy; counters recession
• Increase government spending ( G )
• Decrease taxes ( T )
• Contractionary policy; counters inflation
• Decrease government spending ( G )
• Increase Taxes ( T )
Time for some graphing!
TWO OTHER WAYS OF
CATEGORIZING FISCAL POLICY
• Discretionary
• Changing the level of Government Spending
and/or Taxes in order to return the economy to
full employment.
• Policy makers doing fiscal policy in response to
an economic problem
• Automatic
• Takes place without policy makers having to
respond to current economic problems.
• Unemployment compensation & marginal tax
rates are examples of automatic policies.
WHAT ARE THE WEAKNESSES
OF FISCAL POLICY
• Lags
• Inside lag – The time it takes to recognize economic
problems, promote solutions, and implement policy
change.
• Outside lag – The time it takes for newly
implemented policy to have a noticeable effect in the
economy.
• Political Motivation
• Politicians are more likely to support expansionary
rather than contractionary fiscal policy.
CROWDING OUT
• Fiscal Policy may lead to deficits (1st we must understand this)
• Crowding out is a possible side effect of expansionary Fiscal Policy.
This effect may be caused by the government engaging in deficit
spending. In order to fund deficit spending, the government must
barrow money. This increases the demand for loanable funds.
Increased demand for loanable funds raises the cost of loanable funds
(borrowing). The cost of borrowing is the real interest rate ( r ). The
result then is that r increases.
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 AD

 Xn
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• Finally, the loanable funds graph
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 X and M

 $
 AD
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 D$

 Ig

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• Don’t forget that … r

• We already know that… r