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How does the Government Stabilizes the
Economy?
The Government has
two different tool
boxes it can use:
1. Fiscal PolicyActions by Congress to
stabilize the economy.
OR
2. Monetary PolicyActions by the
Federal Reserve
Bank to stabilize the
economy.
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For now we will only focus on Fiscal Policy.
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Fiscal Policy
Actions taken by Congress to
stabilize the economy
Business
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There are two types of Fiscal Policy
Discretionary Fiscal Policy
and
Non-Discretionary Fiscal Policy
“Use your discretion”
discretion - the power or right to decide
or act according to one's own judgment;
freedom of judgment or choice
Discretionary Fiscal Policy
Congress chooses to take Action or create
Legislation designed to affect GDP
and stabilize the economy
Tools: Government Spending and Taxation
Problem: It takes time for Congress to decide and act
Ex: In a recession, Congress increase spending
in order to increase GDP.
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Ex: In a recession, Congress increase spending
in order to increase GDP.
increased
government
spending
increased productivity and
money into economy
Increased Government Spending
= Increased GDP
results in increased productivity
and employment in entire economy
more money money
spent in private
business and industry
more jobs and
income for
employees
Non-Discretionary Fiscal Policy
AKA - “Automatic Stabilizers”
Permanent spending or taxation laws
created to work counter cyclically to
stabilize the economy
laws and programs designed to automatically step in when the
economy begins to shift
Ex: Welfare, Unemployment, Min. Wage, etc.
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Non-Discretionary Fiscal Policy
Legislation that act counter cyclically without
explicit action by policy makers.
AKA: Automatic Stabilizers
The U.S. Progressive Income Tax System acts
counter cyclically to stabilize the economy.
• When GDP is down, the tax burden on consumers
is low, promoting consumption, increasing AD.
• When GDP is up, more tax burden on consumers,
discouraging consumption, decreasing AD.
The more progressive the tax system, the greater
the economy’s built-in stability.
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The Economy Is Like A Car
Sometimes it’s moving too slow...
and we need something to speed it up...
Sometimes it’s moving to fast!!!
and we need something to slow it down!!!!
We want the economy moving at a steady pace
Contractionary Fiscal Policy (The BRAKE)
Laws that reduce inflation, decrease GDP
(Close an Inflationary Gap)
• Decrease Government Spending
• Tax Increases
• Combinations of the Two
Expansionary Fiscal Policy (The GAS)
Laws that reduce unemployment and increase GDP
(Close a Recessionary Gap)
• Increase Government Spending
• Decrease Taxes on consumers
• Combinations of the Two
How much should the Government Spend?
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