Download Fiscal and Monetary Policy

Fiscal and Monetary Policy
Chapter 13
Part 4 of the Final Exam Review should be put in the
basket on the projector cart at the beginning of
class.
The answer key for Part 3 is posted around the
room. When you have work time later in class, you
may check your answers. No taking pictures!
Today in class we will complete Chapter 13 and then
you will have the rest of the period to complete your
Global Economy and Stock Projects.
SECTION 1
Fiscal Policy
Two Types of Fiscal Policy
Fiscal policy deals with changes the government makes in
spending or taxation to achieve particular economic goals.
• Expansionary fiscal policy is an increase in government
spending or a reduction in taxes.
• Contractionary fiscal policy is a decrease in government
spending or an increase in taxes.
Two Types of Fiscal Policy
Expansionary Fiscal Policy and the Problem of
Unemployment
Government can use expansionary fiscal policy to decrease the
unemployment rate. This is how it works:
• A high unemployment rate is the result of people not
spending enough money in the economy.
• If the government increases spending or reduces taxes, or
both, consumers will have more money to spend.
• An increase in government spending will mean more
spending in the economy.
• As a result of the increase in total spending, business firms
will sell more goods.
• When business firms sell more goods, they have to hire
more workers to produce the additional goods. The
unemployment rate goes down because more people are
working.
Contractionary Fiscal Policy and the Problem of Inflation
Inflation is the result of too much spending in the economy
compared with the quantity of goods and services available for
purchase.
The government can slow inflation by reducing the amount that
it spends. As a result of the decrease in total spending, firms
initially sell fewer goods. To reduce unwanted inventory, firms
lower prices.
Fiscal Policy and Taxes
After-tax income is the part of income that is left over after
taxes are paid.
If the government lowers taxes, more money is available from
earnings and total spending increases. This leads to increased
sales and hiring, reducing the unemployment rate.
If the government raises taxes, the opposite occurs. After-tax
income is reduced, decreasing spending and causing
unemployment to increase.
People are more willing to work when taxes are lower. If taxes
were 100 percent of earnings, there would be no incentive to
work.
Lower tax rates do not necessarily result in lower tax revenues
for the government. Lower tax rates will likely give incentive
to work more, and may result in increased spending, all of
which provides tax revenue for the government.
SECTION 2
Monetary Policy
Two Types of Monetary Policy
Monetary policy is defined as changes the Fed makes in the
money supply.
An expansionary monetary policy is an increase in the
money supply.
A contractionary monetary policy is a decrease in the money
supply.
Expansionary Monetary Policy and the Problem of
Unemployment
Many economists believe that expansionary monetary policy
lowers the unemployment rate by the following means:
• The Fed increases the money supply.
• This in turn leads to increased spending.
• Increased spending results in increased sales and increased
hiring.
Contractionary Monetary Policy and the Problem of
Inflation
Many economists believe that contractionary monetary policy
works to reduce inflation in the following manner:
• The Fed decreases the money supply.
• A smaller money supply results in lower total spending.
• Firms’ inventories increase because they sell fewer
products.
• Firms reduce prices to lower their inventories.
SECTION 3
Stagflation: The Two Problems Appear Together
Rising Unemployment and Inflation (at the Same Time)
For many years, economists believed that the economy would
experience either high inflation or high unemployment, but not
both at the same time. They believed that unemployment and
inflation moved in opposite directions.
In the 1970s, inflation and unemployment began to move in the
same direction. They both began to increase.
The occurrence of inflation and high unemployment at the
same time is called stagflation.
What Causes Stagflation?
Stagflation may be a result of stop-and-go, on-and-off
monetary policy, or an erratic monetary policy. When the Fed
increases the money supply, prices rise. Inflation begins to set
in, just as the Fed decides to reduce the money supply. This
causes output to decrease and unemployment to increase.
Another cause of stagflation might be a market decrease in
aggregate supply, such as that caused by a storm or a war.