Fiscal Policy Notes

A Review of Reading IP

Fiscal Policy Key Concepts

1. What does fiscal mean?Government spending, debt, revenue

2. Define fiscal policy Federal government using

A) Government SpendingB) Taxation to affect the economy

Fiscal Policy Key Concepts

3. What are the two goals of FP?A) Increase aggregate demand

B) Fight inflation

Challenge Question!!!

1. What institution is responsible for fiscal policy?

A) The Federal ReserveB) The GovernmentC) Commercial BanksD) Economic Advisory Organizations

Expansionary vs. Contractionary

• Expansionary– Make larger

• Contractionary– Make smaller/tighter

Expansionary FP

• Expansionary= expand the amount of money in the economy

4. When will the economy use expansionary FP?When the economy slows (recession)

What is expansionary FP’s plan?– Plan to expand the amount of $ in the economy• This will increase aggregate demand– Increased spending will stimulate the economy

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Contractionary FP

• Contractionary= reduce the amount of money in the economy

5. When will the economy use contractionary FP?During Inflation

What is contractionary FP’s plan?– Plan to reduce the amount of $ in the economy• This will decrease aggregate demand– Decreased spending will stop prices from

getting too high

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Challenge Question!!

• True or False: In a recession, it is a good idea to contract the amount of money in the economy.

Discretionary FP6. What is discretionary FP? Actions taken by the government by choice to correct economic instability

7. What type of active government responses might be used in discretionary FP?

A) Changing taxesB) Changing government spending

Automatic Stabilizers8. What are automatic stabilizers?

Features of fiscal policy that automatically stabilize the economy (such as public transfer payments)

9. What are examples of public transfer payments?Unemployment compensation, food stamps

Automatic Stabilizers10. How do public transfer payments stabilize the economy in a recession?

– More people qualify for government benefits like food stamps in a recession.– They get more money to spend from the government

• This increases aggregate demand and helps the economy

11. How do public transfer payments stabilize the economy when it is growing too fast (inflationary period)?

– Economy is doing well so less people qualify for benefits like food stamps– This takes $ out of the economy, which reduces aggregate demand, and keeps

prices from rising

Automatic Stabilizers12. How do progressive income taxes act as automatic stabilizers during prosperous times?

More people get paid, the more taxes they pay. Taxes prevent some of this increased income from entering the economy, which keeps inflation in check.

13. How do progressive income taxes act as automatic stabilizers during a recession

People make less, taxes less, reduced impact of recession

Challenge Question!!!

True or False: Automatic stabilizers are part of discretionary fiscal policy.

The Purpose of Fiscal Policy

14. What is expansionary fiscal policy designed to do?Stimulate a weak economy to grow

15. What is contractionary fiscal policy designed to do?Slow the economy down to control inflation

Policy 1: Expansionary Fiscal Policy16. In expansionary fiscal policy, does the government want to increase or decrease aggregate demand?

Increase AD

17. Expansionary FP ____________ government spending and ______________ taxes

INCREASESDECREASES

Expansionary Fiscal Policy 18. What example of increased government spending does the book use?

Increased highway spending (build more roads)

19. What taxes might be lowered in expansionary fiscal policy? Why?

Income and corporate taxes. So people will spend more and increase aggregate demand.

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Policy 2: Contractionary Fiscal Policy20. In contractionary FP, does the government want to increase or decrease aggregate demand?

Decrease AD

Contractionary Fiscal Policy21. What is it called when the economy is growing too rapidly and aggregate demand is increasing faster than supply?

Demand-pull inflation

22. Contractionary FP ____________ government spending and ______________ taxes

23. What example does the book give of cuts in government spending?

Cuts in highway construction, education, healthcare

INCREASESDECREASES

Challenge Question

Which of the following is correct?A) Expansionary FP such as decreased government spending is used in periods of inflationB) Expansionary FP such as tax cuts are used in

periods of recessionC) Contractionary FP such as tax cuts are used in periods of recessionD) Contractionary FP such as increased government spending is used in periods of recession

Limitations of FP- Policy Lags

24. Describe the limitations of fiscal policy related to policy lags.

Lags behind economic issues. Takes congress months to decide on a course of action.

Limitations of FP- Political Issues25. Describe the limitations of fiscal policy related to political issues.

The President may not follow the advice of the Council of Economics advisors due to political issues (like reelection).

Challenge Questions!!!!

1. Despite what economic advisors say, would a president who is up for reelection be more inclined to increase taxes or cut taxes?

2. Expansionary fiscal policy involves the use of increased government spending to change economic conditions. In general, do you think democrats or republicans would be more supportive of this type of policy?

3. Contractionary fiscal policy involves the use of decreased government spending to change the economy. In general, do you think democrats or republicans would be more supportive of this type of policy?

Cut taxes

Democrats

Republicans