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Fiscal Policy What is Fiscal Policy? What is Fiscal Policy Used For? What is Fiscal Policy? • Changes in government spending and tax collections to achieve: 1. full employment, 2. control inflation, and 3. encourage economic growth. Fiscal Policy Video Fiscal Policy and the AD/AS Model • Discretionary (active) Fiscal Policy: Changes in Government Spending and Taxes are dependent on the Federal Government. • Non-Discretionary (passive/automatic): Changes are not initiated through the government. Options to Increase AD: Expansionary Fiscal Policy • Expansionary fiscal policy: helps an economy out of recession and to reduce unemployment. 1. Increase government spending (the most direct method). 2. Reduce Taxes. 3. Combination of both to achieve greater effects. Reduce Taxes or Increase G Spending to Solve the Recessionary Gap Why Does the Government Not Always Select Expansionary Policies? • Expansionary Fiscal Policy can create budget deficits (Government Spending > Tax Revenues). • Chronic budget deficits can result in large debts levels, high interest rates, inflation, and economic collapse… The Greek Example. • If the government does not use expansionary fiscal policy. AS will adjust but it takes longer. Contractionary Fiscal Policy: Used to “Cool” the Economy • Reduces demand-pull inflation (when demand shifts out and the price level increase), it is applied when the economy is experiencing over-employment). • It is designed to deal with inflation. • Why do we need to control inflation? How do we Engage in Contractionary Fiscal Policy? Decrease government spending Increase tax Combination of both to achieve greater effects Increase Taxes or Reduce G Spending to Solve the Inflationary Gap What is the Best Policy Option? To change taxes or to change spending? • Economists who support government expansion / size believe in increased government spending during recessions and tax increases to curb inflation. • Economists who want to reduce or limit the size of government believe in tax cuts during recessions and reduced spending to curb inflation. Test and Exam Preparation • Questions 1 and 2, Page 275. • In particular, it is important for you to read up on the “balanced budget multiplier” from the end of chapter eight. Built-In Stability / Stabilization What Happens as GDP Changes? Automatic / Built-in Economic Stabilizers • Fiscal policy is also automatic, rather than discretionary. • It does not always require the government to convene and create expansionary or contractionary plans. • This is because taxes collected decline as GDP falls, since most are income/consumption taxes & government spending/transfers rise. Different Taxation Policies: The More Progressive, the More Stability Progressive Taxes ($ up, Taxes up) (GDP up, Avg Tax up) Proportional Taxes (Tax same % for all people) (GDP up, Avg Tax same) Regressive Taxes ($ up, Taxes down) (GDP up, Avg Tax down) Progressive Taxes. How Much Would I pay in Ontario? Employment Income Taxes Owed 20 000 1 912 (9.6%) 40 000 5 962 (14.9%) 60 000 12 002 (20%) 80 000 18 486 (23.1%) 100 000 26 913 (26.9%) 500 000 211 579 (42.3%) Test and Examination Preparation • Page 275 # 4