Transcript problems of fiscal policy

FISCAL POLICY
Demand-Side (Keynesian View)
 Supply-Side
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Changing tax rates will affect Aggregate Supply as
well as Aggregate demand
Advocate lower marginal tax rates in the belief that:
Lower taxes increase the incentive to work
 Lower taxes encourage risk-taking and the creating of
more new products and technologies
 Lower taxes increase household savings and thus the
funds available for investment will increase.

PROBLEMS OF
FISCAL POLICY
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WHAT DO TAX RATE UPS AND DOWNS MEAN
FOR ECONOMIC GROWTH?
…AN HISTORIC EXAMPLE
Problems With Fiscal Policy
Deficit Spending!!!!
•Debt vs Deficit
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Problems With Fiscal Policy
Deficit Spending!!!!
•A Budget Deficit is when the government’s
expenditures exceeds its revenue.
•The National Debt is the accumulation of all the
budget deficits over time.
•If the Government increases spending without
increasing taxes they will increase the annual
deficit and the national debt.
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Most economists agree that budget deficits are a
necessary evil because forcing a balanced budget
would not allow Congress to stimulate the
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economy.
US Debt Clock
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Additional Problems with Fiscal Policy
1. Problems of Timing
• Recognition Lag- Congress must react to
economic indicators before it’s too late
• Administrative Lag- Congress takes time
to pass legislation
• Operational Lag- Spending/planning takes
time to organize and execute ( changing
taxing is quicker)
2. Politically Motivated Policies
• Politicians may use economically
inappropriate policies to get reelected.
• Ex: A senator promises more welfare and
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public works programs when there is already
an inflationary gap.
Additional Problems with Fiscal Policy
3. Crowding-Out Effect
• Government spending might cause
unintended effects that weaken the impact of
the policy.
Example:
• We have a recessionary gap
• Government creates new public library. (AD
increases)
• Now but consumer spend less on books (AD
decreases)
Another Example:
• The government increases spending but must
borrow the money (AD increases)
• This increases the price for money (the interest
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rate).
• Interest rates rise so Investment to fall. (AD
Additional Problems with Fiscal Policy
4. Net Export Effect
International trade reduces the
effectiveness of fiscal policies.
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Example:
We have a recessionary gap so the
government spends to increase AD.
The increase in AD causes an increase in
price level and interest rates.
U.S. goods are now more expensive and the
US dollar appreciates…
Foreign countries buy less. (Exports fall)
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Net Exports (Exports-Imports) falls,
decreasing AD.
Explain this cartoon
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ACTIVITY
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CONGRESSIONAL
COMMITTEES ACTIVITY
As a group, analyze the situation, identify
the problem, and identify your solution
The Good, the Bad, and the Ugly
Unemployment
Inflation
GDP Growth
Good
6% or less
1%-4%
2.5%-5%
Worry
6.5%-8%
5%-8%
1%-2%
8.5 % or more
9% or more
.5% or less
Bad
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1.) 1933
Situation:
GDP fell -1.2%
Inflation rate= -.5%
Unemployment Rate=25%
Your Solution:
What actually happened:
FDR increased public works via
the New Deal programs.
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2.) 1944
Situation:
 GDP grew 8%
 Inflation rate= 3.7%
 Unemployment Rate=1.2%
Your Solution:
What actually happened:
 War ended the next year and
government orders for war materials
decreased.
 Many public works programs were
discontinued
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3.) 1980
Situation:
 GDP fell -0.3%
 Inflation rate= 13.5%
 Unemployment Rate=7.1%
Your Solution:
What actually happened:
 The next year, President Regan and
congress lowered taxes on individuals
and corporations by about 30%.
(Supply-side Economics)
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4.) 2003
Situation:
GDP fell 0.5%
Inflation rate= 1.5%
Unemployment Rate=12.0%
Your Solution:
What actually happened:
Congress voted to give tax cuts to
citizens. (Bush Tax Cuts)
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ANALYZING THE
MACROECONOMY