Download 222 Fiscal Policy: the purposeful movements in government

FISCAL POLICY
CHAPTER OBJECTIVES
At the conclusion of this chapter you will
understand discretionary and nondiscretionary
fiscal policy and how the aggregate supply and
aggregate demand model can be used to
demonstrate how they work. You will be able to
distinguish between aggregate demand and
aggregate supply shocks. Finally you will
understand that there are considerable problems
associated with discretionary fiscal policy but that
nondiscretionary fiscal policy is a mainstay of our
current macroeconomic system.
CHAPTER OUTLINE
CHAPTER OBJECTIVES
INTRODUCTION
NONDISCRETIONARY AND
DISCRETIONARY FISCAL POLICY
How They Work
Using Aggregate Supply and
Aggregate Demand to Model Fiscal
Policy
USING FISCAL POLICY TO
COUNTERACT “SHOCKS”
Aggregate Demand Shocks
Aggregate Supply Shocks
EVALUATING FISCAL POLICY
Nondiscretionary Fiscal Policy
The Mistiming of Discretionary
Fiscal Policy
The Political Problems with Fiscal
Policy
The Abandonment of Discretionary
Fiscal Policy
CHAPTER SUMMARY
INTRODUCTION
When someone wants government “to do
something” about the economy they are typically
Fiscal Policy: the purposeful movements in
government spending or tax policy designed to
direct an economy
referring to fiscal policy, which was considered a
vital tool in macroeconomics at one time. Fiscal policy is the purposeful movements in government
spending or tax policy designed to direct an economy. In the United States, fiscal policy is determined
by the Congress and the President.
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Fiscal policy is not simply one idea, it is
really two. Discretionary fiscal policy consists of
actions taken at the time of a problem to alter the
economy of the moment. Nondiscretionary fiscal
Discretionary Fiscal Policy: government
spending and tax changes enacted at the time of
the problem to alter the economy
Nondiscretionary Fiscal Policy: that set of
policies that are built into the system to stabilize
the economy
policy is that set of policies that are built into the
system to stabilize the economy when growth is either too fast or too slow.
Discretionary and nondiscretionary fiscal policy will first be described. Then we will explain the
benefits of nondiscretionary fiscal policy and explain why it is that discretionary fiscal policy cannot claim
similar benefits. We will use that discussion to explain why policy makers have abandoned discretionary
fiscal policy in the last 20 years. We will finish by offering ideas on how current tax and spending policies
might be changed in ways that could salvage what is left of discretionary fiscal policy.
NONDISCRETIONARY AND DISCRETIONARY FISCAL POLICY
How They Work
The difference between nondiscretionary and discretionary fiscal policy is that one is automatic
and the other is not. Nondiscretionary fiscal policy, for example, includes government policies that
stimulate the economy when it needs stimulus and dampen it when it needs to be dampened. Under
discretionary fiscal policy Congress and the President agree on a course of action to stimulate or
dampen the economy at a specific time.
Nondiscretionary fiscal policy is at work everyday as a result of policies enacted years ago.
Every time you get a raise, move to a better job, or make a killing in the stock market, the government
takes a portion of your improved income in taxes. The effect on your assets becomes more pronounced
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as you advance in the tax brackets, because when you make more money you pay a higher percentage
of that income in taxes. If you happened to have been a welfare recipient and you have found a job, the
effect is even greater. Not only is the government now not providing you with money, it is withholding
taxes from your pay. In both cases, the effect of nondiscretionary fiscal policy is dampening the increase
in your income.
Of course, nondiscretionary fiscal policy can have the opposite effect as well. If you lose your
job, get demoted, or lose a lot of money in the market, your tax burden falls. If you lose your job and go
back on welfare the effect is again magnified. The government is not taking money from you but is giving
money to you. This stimulates the economy somewhat, and it thus has the effect of helping to counteract
the loss you incurred.
Because our progressive income tax system increases the percentage that you pay in taxes as
you make more money and because federal and state programs are in place that offer economic
assistance when you need it, nondiscretionary fiscal policy is constantly working to stabilize the
economy. No one has to use any discretion, i.e., make any decisions, in order to make it work.
Therefore it is called nondiscretionary fiscal policy. Because the actions are built into the system,
nondiscretionary fiscal policy is often referred to as a built-in stabilizer.
With discretionary fiscal policy, on the other hand, action is required by Congress and the
President. When each decides that the economy is in need of a specific action that will properly stimulate
or dampen it, the usual actions that they consider involve changes in taxes or spending policies.
Historically, fiscal policy has been used to stimulate an economy in recession but rarely to dampen an
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economy that is running too hot.8
The specific policy actions used in the past involved cutting taxes and funding public works
projects to give jobs to persons who were unemployed. In the middle 1970's, for example, President
Gerald Ford sought to provide each taxpayer with a tax rebate of $50. During the Great Depression
many unemployed workers found jobs in government programs that built roads, dams, and bridges.
Using Aggregate Supply and Aggregate Demand to Model Fiscal Policy
It is useful for us to look at the effect of both forms of fiscal policy using our Aggregate Supply
and Aggregate Demand Model. Both discretionary and nondiscretionary fiscal policy work to move the
Aggregate Demand Curve. Figure 1 shows the effect of expansionary fiscal policy while Figure 2 shows
the effect of contractionary fiscal policy. Expansionary fiscal policy options, such as increased
government spending and decreases in taxes, are
reflected in an aggregate demand curve that moves
to the right. Contractionary fiscal policy options,
including decreased government spending and
increases in taxes, are seen in an aggregate demand
curve that moves to the left.
Figure 1 Contractionary Fiscal Policy
A decrease in government spending or an increase in
taxes will decrease aggregate demand. This moves the
aggregate demand curve to the left. The result is a
decrease in RGDP and prices.
8
A one-year 10% surtax was added to income taxes in the Johnson administration. Some
justified this action as an effort to combat inflation.
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It should be noted that there is considerable
debate over whether any fiscal policy will have a
real impact on the economy. A useful but relatively
simplistic way of thinking about this argument is to
frame it in terms of where on the aggregate supply
curve the economy lies. Those that believe that we
are on the vertical portion of the curve argue that
Figure 2 Expansionary Fiscal Policy
any expansionary fiscal policy will be completely
An increase in government spending or a decrease in
taxes will increase aggregate demand. This moves the
aggregate demand curve to the right. The result is an
increase in RGDP and prices.
ineffective. It will merely create inflation without
bolstering output.
It is worth mentioning that the money necessary to engage in expansionary fiscal policy does not
come out of thin air. The increased government spending and the reduced tax revenue generate a
shortfall and must be made up with either borrowing or printing the requisite money. Economists do not
consider the latter option a good one in that inflation is nearly always the result. Thus, deficits financed
through borrowing money tend to be result of expansionary fiscal policy.
USING FISCAL POLICY TO COUNTERACT “SHOCKS”
Aggregate Demand Shocks
Neither of these actions happens in a
vacuum. They happen because the economy
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Shock: any unanticipated economic event
moves unexpectedly to make RGDP much higher or much lower than policy makers think is healthy.
Figures 3 and 4 show how fiscal policy works in reaction to these unexpected moves. In each we
suppose that aggregate demand is what moves unexpectedly, and in each we start with it at AD1.
Because of a shock it unexpectedly moves to AD2. Nondiscretionary fiscal policy (NDFP) moves it
back toward AD1 to AD3, and discretionary fiscal policy (DFP) can move it all the way back to AD1
again. In theory, whether the economy experiences a positive demand shock or a negative one, the
government can use both discretionary and nondiscretionary fiscal policy to get us back to a healthy
economy.
Figure 3 Nondiscretionary and Discretionary
Fiscal Policy as it Combats a Recession
If a slump in aggregate demand causes a recession, then
the aggregate demand curve moves from AD1 to AD2.
When people lose their jobs, welfare spending will have
to rise and tax revenue will fall. This non-discretionary
fiscal policy moves the aggregate demand curve partially
back to AD3. Expansionary discretionary fiscal policy
(either increases in government spending or decreases in
taxes) can move aggregate demand all the way back to
A D1.
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We need to ask at this point how it is that
aggregate demand can move unexpectedly. There
Aggregate Demand Shock: an unexpected
event which causes aggregate demand to
increase or decrease
are a number of reasons and each involves the
reaction of people to their predictions of the future.
If people’s positive view of the health of the
economy spurs them to buy new cars or
furnishings, an aggregate demand curve will move
to the right. If the opposite happens and people
decide to delay buying these expensive items
because of negative feelings about the economy,
Figure 4 Nondiscretionary and Discretionary
Fiscal Policy as it Combats an Overheated
Economy
If a jump in aggregate demand causes an overheated
economy, then the aggregate demand curve moves from
A D1 to AD2. When people get better jobs or raises,
welfare spending will fall and tax revenue will rise. This
nondiscretionary fiscal policy moves the aggregate
demand curve partially back to AD3. Contractionary
discretionary fiscal policy (either decreases in government
spending or increases in taxes) can move aggregate
demand all the way back to AD1.
the aggregate demand curve will move to the left.
Tracking the “feeling” that people have about the economy is not easy and therefore large unexpected
swings can upset the economy. Economists call these swings aggregate demand shocks.
Aggregate Supply Shocks
Figures 5 and 6 show that along with
aggregate demand shocks we must also deal with
Aggregate Supply Shock: an unexpected event
which causes aggregate supply to increase or
decrease
the problem of aggregate supply shocks. Usually
aggregate supply shocks happen when an important natural resource is involved. It should come as no
surprise that recent supply shocks have all involved the price of oil. During the 1973 Arab-Israeli war,
for example, the price of oil climbed dramatically. During the Iran-Iraq war, the price of oil fell
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dramatically as both sides increased production to pay for war material. Whether drastic changes are
positive or negative, policy makers may wish to use discretionary fiscal policy so as to counter an
aggregate supply shock.
In both Figures 5 and 6 we start out with AS 1 crossing AD1 so that prices are at P* and output
is at RGDP*. A hypothetical shock moves aggregate supply to AS 2. If the supply shock is negative and
it raises input prices substantially, as in Figure 5, people will lose their jobs as RGDP falls.
Nondiscretionary fiscal policy will kick in at this point, though, because the loss of jobs will mean an
increase in welfare spending and a decrease in taxes. This will cause aggregate demand to shift to the
right to AD2. If the President and Congress then decide to go further with discretionary fiscal policy in an
effort to get output back to RGDP*, they will have to cut taxes or raise spending to do so. The problem
is that the shock itself and the nondiscretionary fiscal policy that was implemented has already created
high inflation. Discretionary fiscal policy can only serve to worsen the problem.
On the other hand, if the supply shock is that input prices have fallen, as has been depicted in
Figure 6, output increases. Nondiscretionary fiscal policy is such that taxes go up and welfare spending
goes down. When that happens aggregate demand falls to AD2. In this case there is no need for
discretionary fiscal policy, because, even though there is a shock, it is only for the good. Both the shock
and the nondiscretionary fiscal policy also serve to calm inflation.
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Figure 5 Nondiscretionary and Discretionary
Figure 6 Nondiscretionary Fiscal Policy in the
Fiscal Policy in the Wake of a Negative Aggregate Wake of a Positive Aggregate Supply Shock
If a supply shock is as a result of a decrease in business
Supply Shock
If a supply shock causes a recession, then the aggregate
supply curve moves from AS1 to AS2. When people lose
their jobs welfare spending will have to rise and tax
revenue will fall. This non-discretionary fiscal policy
moves the aggregate demand curve to AD2. Expansionary
discretionary fiscal policy (either increases in government
spending or decreases in taxes) can move aggregate
demand to AD3 so as to get RGDP back to where it was
before the supply shock. Doing so vastly increases
prices.
costs, then the aggregate supply curve moves from AS1
to AS2. When people get better jobs or raises, welfare
spending will fall and tax revenue will rise. This
nondiscretionary fiscal policy moves the aggregate
demand curve to AD2. There is no need for discretionary
fiscal policy here because we are getting more RGDP and
lower prices: two good things.
EVALUATING FISCAL POLICY
Nondiscretionary Fiscal Policy
Nondiscretionary fiscal policy serves to get output moving back toward the desired level,
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RGDP*, but it works much better when the shock is to aggregate demand rather than to aggregate
supply. In addition, even though previous Congresses and Presidents have developed tax and spending
policies in order to get us out of a recession, such discretionary fiscal policy just does not work as well
as does nondiscretionary policy.
Since the Great Depression of the 1930's the U.S. economy has successfully avoided the sorts
of boom and bust cycles that plagued the 19th century. The degree to which the built-in stabilizing effect
of a welfare state and a progressive tax system generated this state of affairs is debated by economic
historians. The recession of 1982, our worst since World War II, was far less onerous than any of the
financial panics of the 1800's.
The Mistiming of Discretionary Fiscal Policy
You might think, then, that discretionary fiscal policy would work as well. If you did you would
be wrong, but you would be in good company. By the 1950's and 1960's most economists were
confident that discretionary fiscal policy would essentially eliminate the instability of recessions. By 1980
most economists had given up on discretionary fiscal policy. Coincidentally or not, during the twenty
years that followed, we experienced half the usual number of recessions.
What transformed economists from overconfident discretionary fiscal policy champions in the
1960's to ardent detractors in the 1980's was the very poor performance of these policies during the
1970's. While the aggregate demand and aggregate supply analysis above is nice to look at, and while
the nondiscretionary fiscal policy part does work as advertised, discretionary fiscal policy was more of
a fantasy of economists. In the 1950's and 1960's economists were confident that Congress could know
exactly how much stimulus or dampening would be necessary to get the economy back to a desired level
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of RGDP. Congress would then pass a bill that the President would sign to implement that policy. As a
practical matter, it just did not work in the ways economists predicted it would.
The reasons discretionary fiscal policy
does not work can be attributed to lags in
recognizing, administering, and operating fiscal
policy. The first, the recognition lag, is that the
economy in general, and RDGP in particular, are
measured with a considerable lag. The second,
Recognition Lag: the time it take to measure
the state of the economy
Administrative Lag: the time it takes for
Congress to agree on a course of action with the
President
Operational Lag: the time it takes for the full
impact of a government program or tax change
to have its effect on the economy
the administrative lag, results because it takes
time for Congress to agree on a course of action with the President. The third, the operational lag
results because it takes quite a while for the full impact of a government program or tax change to have
its effect on the economy.
The recognition lag results from the fact that Gross Domestic Product is not easily and
immediately measured. Quarterly GDP is first estimated using reasonably good predictors that are
available soon after the end of the quarter. Later, more data is brought to bear and it is re-estimated.
Only after many months is a final GDP figure given. As a result we do not know for sure whether we are
in a recession until months after it begins. Similarly, we do not know when we are out of a recession until
months after it ends. The problem this creates was highlighted by the recession we experienced in 1990.
That recession began in the third quarter of 1990, and it ended in the second quarter of 1991. We did
not know for sure that it was a recession until spring of 1991. Had Congress and the President acted as
soon as we knew we were in recession, the action they took would have still been six months or more
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too late. At the recession’s end the economy was growing so slowly that many in 1992 still thought we
were in recession. The problem with recognizing a recession too late is that not only can actions be
instituted that do not help, but they can end up overheating an economy that is already on the mend.
The administrative lag results from the inherent inefficiency of American democracy. We have
two legislative bodies that must first agree with each other, and they must agree with the President. The
President, the House or the Senate can delay or derail fiscal policy. Even if they choose to work on a
given problem, Congress never solves a problem without disagreements. They may agree, for example,
that we are in a recession but will not be able to decide whether to engage in discretionary fiscal policy
through tax cuts or through spending programs. Even when they agree on that, they may argue over the
kinds of tax cuts to make, who should get them, what kinds of spending programs would be appropriate,
and the congressional districts that should be benefitted. By the time they finally agree, of course, more
time has passed.
The operational lag offers the final roadblock to effective discretionary fiscal policy. Even
supposing that Congress and the President agree on time that a policy is needed, and they agree on the
type of policy, it takes months, if not years, for discretionary fiscal policy to have its desired effects.
Changes in tax laws, for example, are not felt by most people until a full year and a half after they are
passed. Most tax law changes are not retroactive, which means they apply to the next tax year. Tax
forms, moreover, are not due until April 15th of the year following the tax change. While some tax
changes are retroactive and while some people do change their withholding to take advantage of tax cuts
early, changes in taxes are generally very slow in becoming effective.
If the discretionary fiscal policy takes the form of increases in highway construction, a program
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that increases the numbers of jobs available, federal contracts usually do not pay the entire amount up
front. Contractors are paid in the stages of building, and it takes quite a while to go from the beginning of
a large construction project to its end. As with changing tax laws, much of the money in the contract may
hit the economy well after it is needed.
The Political Problems with Fiscal Policy
Another argument against discretionary fiscal policy is that even if it worked, vote-obsessed
politicians would not use it properly. Aside from the bias toward expansionary fiscal policy alluded to in
the introduction there is the question of who will be affected by any changes in taxation or spending
policies. In addition, there is the complication caused by politicians too concerned with re-election. They
seek to expand the economy in Presidential election years only to act responsibly after the election.
The first of these issues raises questions of political motovation. Whether large scale, federally
funded building projects are needed is one question; where they will go is quite another. For instance,
whether the revamped Boston mass transit system, referred by many as the “big dig,” was motivated by
purely engineering reasons or because influential members of Congress lived in the area is debatable.
Similarly, critics have charged that political influence alone was the reason behind the fact that a majority
of highway demonstration projects in the early 1990's were in West Virginia. Noted economist James
Buchanan and others have suggested that all federal spending, but in particular that spending that is done
in the name of fiscal policy, is susceptible to this kind of problem.
There is also the problem of the political
business cycle. It is suggested that politicians,
and in particular, Presidents, will add new
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Political Business Cycle: politically motivated
fiscal policy used for short term gain just prior to
elections
spending and tax policies to their pre-election-year budgets to boost the economy in time for their own
or their party’s reelection. The table below suggests that this might be the case, given that the average of
growth rates in the fourth year of Presidential terms of office are slightly higher than first year growth
rates.
Table 1
Real Growth Rates
by Presidential Terms
First
Truman
Eisenhower I
Eisenhower II
Kennedy/Johnson
Johnson
Nixon I
Nixon II/ Ford
Carter
Reagan I
Reagan II
Bush GHW
Clinton I
Clinton II
Average
Second
Third
Fourth
-1.6%
0.4%
0.3%
6.3%
8.5%
1.9%
4.0%
5.0%
1.2%
4.0%
2.6%
2.5%
4.3%
13.4%
2.7%
2.3%
4.1%
4.4%
-0.1%
-2.1%
6.6%
-1.6%
2.8%
0.5%
4.1%
4.6%
5.1%
6.5%
5.1%
5.2%
2.3%
4.4%
2.6%
1.4%
7.6%
4.4%
0.9%
2.2%
5.0%
5.3%
1.9%
0.6%
5.1%
5.0%
7.2%
4.6%
-0.1%
5.6%
3.7%
4.0%
4.1%
3.0%
3.2%
4.0%
3.9%
Source: http://www.bea.doc.gov/bea/dn/gdplev.htm
The Abandonment of Discretionary Fiscal Policy
In the 1970's it became apparent to policy makers that discretionary fiscal policy was not up to
the task of stabilizing the economy. The lags were just too important to ignore and the recessions of the
1970's had been too short for these recessions to be recognized, laws to be passed, and money spent in
time to have any effect on them.
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Despite the preceding cautions about the effectiveness of discretionary fiscal policy, its
arguments have been used to bolster particular programs. President William Clinton used the
discretionary fiscal policy argument in 1993 to bolster a $16 billion investment program. Critics defeated
his proposal suggesting that we were already out of the recession and its size was too small to have any
impact. President George W. Bush sought a large tax cut in the early part of his administration using
what he saw as an impending recession to justify it. That he was in favor of the identical tax cut during
the campaign when there was no such fear suggests that fiscal policy was unlikely his true motivation and
that the tax cut was an end in itself.
Economists now mostly agree that the only potential function for traditional discretionary fiscal
policy might lie in helping to lessen severe, long-lasting recessions. They would have to be recessions,
though, that no one could fail to recognize, perhaps because of massive layoffs. They would have to be
ones in which politicians felt compelled to act. If policy makers thought a recession was likely to last
more than a couple of years, and if they were right, actions to jumpstart the economy might well be
effective. Short of that, however, most economists now believe that monetary policy is the only effective
tool for maintaining a stable economy.
As a result, there are few economists who put much faith in discretionary fiscal policy. Though
monetary policy and nondiscretionary fiscal policy work reasonably well, they do so because they avoid
the lag involved in Congressional and Presidential bickering. One way that discretionary fiscal policy
might do this would be to make it semi-nondiscretionary. If policies were enacted well before they were
needed, that would give future Presidents the power to act. At their discretion Presidents could enact
provisions of previously signed laws and we might avoid one, if not two, of the three existing lags.
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While any policy that we choose is subject to the operational lag, we could avoid most of the
recognition lag and all of the administrative lag by having certain tax and spending policies ready to be
implemented with a signature. For instance, Congress could pass appropriations bills that would
authorize enough money to repair, to build or to rebuild certain highways, dams, or bridges. They could
then authorize that the money only be spent when future Presidents certified that they believed a
recession was imminent. If that were done, future Presidents could use leading indicators of a recession
to act, even before one took hold. They could do so without having to go to Congress again.
Admittedly, this would require an unprecedented level of trust between the two branches of
government in that 1) a President could seriously misuse this power for political reasons, and 2) many
roads, dams, and bridges cannot wait for the next recession. Previous Congresses and Presidents have
tried various methods to circumvent or otherwise make appropriations more efficient. The line-item veto
and the Military Base Closure Commission are just two examples. The first died because it was held to
be unconstitutional. The second died because Republicans became convinced President Clinton
corrupted what had previously been accepted as a non-political process. The charge emanated from his
use of provisions that enabled him to save certain bases in electorally important California and Texas.
Rightly or wrongly, this perception destroyed the politics-free environment that Congress had envisioned
when it authorized the Commission to close large numbers of military bases in the late 1980's.
As we have said, the other problem with having an amount of money set aside for a future
spending program is that if the benefits of the program are so clear, then why does it make any sense to
delay spending the money? Also, roads, dams, and bridges fall into disrepair at a rate of their own
choosing. They do not wait for recessions to crumble, burst, or fall down.
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In short, discretionary fiscal policy is pretty much a dead letter.
CHAPTER SUMMARY
You now understand the difference between discretionary and nondiscretionary fiscal policy and
know how to model them using an aggregate supply and aggregate demand diagram. You understand
that policies used to counteract aggregate demand and aggregate supply shocks are different. You also
now understand, too, that there are considerable problems associated with discretionary fiscal policy but
that nondiscretionary fiscal policy is a mainstay of our current macroeconomic system.
Fiscal Policy
Discretionary Fiscal Policy
Nondiscretionary Fiscal Policy
Shock
Aggregate Demand Shock
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KEY TERMS
Aggregate Supply Shock
Recognition Lag
Administrative Lag
Operational Lag
Political Business Cycle
Quiz Yourself
Nondiscretionary Fiscal Policy
a) involves deliberate actions of Congress and the President to alter the economy.
b) involves the use of tax and welfare policy to constantly increase RGDP.
c) involves the use of tax and welfare policy to accentuate changes in RGDP.
d) involves the use of tax and welfare policy to counteract changes in RGDP.
Discretionary Fiscal Policy
a) involves deliberate actions of Congress and the President to alter the economy.
b) involves the use of tax and welfare policy to constantly increase RGDP.
c) involves the use of tax and welfare policy to accentuate changes in RGDP.
d) involves the use of tax and welfare policy to counteract changes in RGDP.
Because we have ________ and ________ we have nondiscretionary fiscal policy
a) national defense and property taxes.
b) Congress and a President.
c) progressive taxes and a welfare state.
d) all of the above.
Which of the following would be (an) example(s) of expansionary discretionary fiscal policy
a) increases in defense spending
b) increases in taxes
c) increases in road construction
d) all of the above
e) a) and c)
Which of the following would be (an) example(s) of contractionary discretionary fiscal policy
a) increases in defense spending
b) increases in taxes
c) increases in road construction
d) all of the above
e) a) and c)
The operational lag of discretionary fiscal policy refers to the fact that
a)
we may not know we are in a recession until well after we are in it.
b)
it takes time for the Congress and President to agree on a plan for government spending
and taxes.
c)
it takes time for a project to get started and have its impact felt in the economy.
d)
all of the above
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An increase in oil prices
a) would be a supply shock.
b) would be a demand shock.
c) could be effectively handled using discretionary fiscal policy.
d) none of these
A concern that a recession was nearing could be self-fulfilling because
a) it would be a supply shock.
b) it would be a demand shock.
c) nondiscretionary fiscal policy could not be counted on to help counter the effects.
d) none of these
The movement of GDP that results politicians desires for re-election is called the
a) business cycle
b) the political business cycle
c) the operational business cycle
d) the corruptible business cycle
Draw an aggregate supply-aggregate demand diagram to show the difficulty of combating an increase in
oil prices with fiscal policy.
Think About This
What kinds of projects (road or bridge work, school or park construction, etc.) could you think of in
your city or town that need to be done where discretionary fiscal policy might be used?
Talk About This
If discretionary fiscal policy has the three lags (recognition, administrative, and operational), should the
federal government just stand by and do nothing or should it use discretionary fiscal policy even with its
flaws?
Should the Congress and President engage in discretionary fiscal policy if a recession is caused by a
supply shock? What would be the cost of doing so?
For More Insight See
Various articles written by Alberto Alesina, John B. Taylor, Alan Auerbach and Daniel Feenberg and
Douglas Elmendorf and Louise Sheiner in Journal of Economic Perspectives Summer 2000 Vol 14
No 3
Any textbook entitled “Intermediate Macroeconomics”, will have a chapter on Fiscal Policy.
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