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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. AD Xn • Finally, the loanable funds graph X and M $ AD D$ Ig • Don’t forget that … r • We already know that… r