Transcript Fiscal Policy Government action to influence the economy

Fiscal Policy
Government actions and decisions
to influence the economy
Reference 15.1
Fiscal Policy
Government Action (Executive, Legislative)
(not monetary policy conducted by FRB)
• Expansionary: Increase total spending to
reduce unemployment
• Contractionary: Reduce total spending to
reduce inflation
Typical Business Cycle
When might the government
employ Expansionary Fiscal Policy ?
• During recessions
• During periods of high unemployment
• Maybe just before the next election
“It’s the economy, Stupid”
Expansionary Fiscal Policy
•
The government can decide to:
1. Increase government spending (jobs)
2. Lower taxes (increase aggregate demand)
3. Do both
Will this policy achieve its goal????
maybe…
• Many variables
• Will additional government spending
“crowd out” private spending?
• Crowding-out: government spending
leads to reductions in private spending
• Example: An additional $2,000,000 dollars spent on
education by government may result in consumers
spending $2,000,000 less on private school tuition.
John Maynard Keynes
The General Theory of Employment, Interest, and Money
(1936)
• 1883-1946
• Revolutionizes thinking about
the government’s role in the
economy.
– Influential to the “New Deal”
• Argued for expansionary
fiscal policy in times of
recession or depression
• Increasing
government spending
will spur the economy
to create more jobs
Typical Business Cycle
Contractionary Fiscal Policy
•
The government can decide to:
1. Reduce government spending
2. Increase taxes
3. Do both
NOT VERY POPULAR…But will it work?
maybe…
• Will private spending “crowd in”? Will
consumers spend more when faced with
less government spending?
• Crowding-in: decreases in gov. spending
lead to increases in private spending
• Example: The schools are so under-funded
that parents spend money to put their kids in
private schools.
How Taxes Can Affect Spending
• After-tax income: what you have left to
spend after you’ve paid income taxes.
• Higher after-tax income increases demand
(expansionary) low tax rate
• Lower after-tax income decreases demand
(contractionary) high tax rate
Marginal Tax Rates
• Current Issue: How will the repeal of the
Bush tax cuts affect the economy?
How Taxes Can Affect Supply
• If you were taxed at 100%, would you
work?
• High tax rates can reduce productivity
Tax Rates ….Tax Revenues
• Will higher tax rates give the government greater
tax revenues?
• Will lower tax rates give the government smaller
tax revenues?
Only if INCOME is constant.
Laffer Curve
• controversial theory
• created by economist Arthur Laffer
• represents the relationship between tax
rates and tax revenues.
• What is the ideal tax rate?
Review
• What is expansionary fiscal policy, and for
what purpose is it likely to be
implemented?
• What is contractionary fiscal policy, and for
what purpose is it likely to be
implemented?
Review
• Is expansionary fiscal policy always
effective at increasing total spending and
decreasing unemployment?
• Explain your answer.
Review
• Someone says, “If the federal government
cut income tax rates, tax revenues will
fall.” Might this person be wrong?
Explain your answer.
Class/Homework:
• 16.2 Budget: Deficits and Surpluses
– Read and note
– Complete Section Review #1-5