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Chapter 27 Fiscal Policy 1 © 2006 Thomson/South-Western Fiscal Policy Fiscal policy refers to government purchases, transfer payments, taxes, and borrowing as they affect macroeconomic variables such as real GDP, employment, the price level, and economic growth Two categories Automatic stabilizers Discretionary fiscal policy 2 Automatic Stabilizers Structural features of government spending and taxation that reduce fluctuations in disposable income, and thus consumption, over the business cycle 3 Discretionary Fiscal Policy The deliberate manipulation of government purchases, taxation, and transfer payments to promote macroeconomic goals, such as full employment, price stability, and economic growth Requires ongoing congressional decisions President Bush’s tax cuts 4 Tools of Discretionary Fiscal Policy 5 Government Purchases Multiplier As long as consumption is the only spending component that varies with income, the multiplier for a change in government purchases, other things constant, equals Thus, we can say that for a given price level, and assuming that consumption varies with income 6 Change in Net Taxes A change in net taxes also affects real GDP demanded, but the effect is less direct 7 Simple Tax Multiplier The effect of a change in net taxes on real GDP demanded equals the resulting shift in the consumption function times the simple spending multiplier: Therefore, the change in real GDP can be determined as 8 Expansionary Fiscal Policy An increase in government purchases, decrease in net taxes, or some combination of the two aimed at increasing aggregate demand enough to return the economy to its potential output thereby reducing unemployment; policy used to close a 9 Contractionary Fiscal Policy A decrease in government purchases, increase in net taxes, or some combination of the two aimed at reducing aggregate demand enough to return the economy to potential output without worsening inflation; policy used to close an 10 Automatic Stabilizers Automatic stabilizers smooth fluctuations in disposable income over the business cycle, thereby boosting aggregate demand during periods of recession and dampening aggregate demand during periods of expansion Two good examples of automatic stabilizers 11 Problems with Fiscal Policy Other concerns policy makers to question the effectiveness of discretionary fiscal policy 12 Lags in Fiscal Policy Lag: the time required to approve and implement fiscal legislation 13
