ECON 2020 Ch. 16: Fiscal Policy

fiscal policy

involves government's budget tools, gov't spending, and taxes to influence macroeconomy; generally focuses on AD

expansionary fiscal policy

occurs when the gov't increases spending or decrease taxes to stimulate economy toward expansion during downturns
(INCREASES AD)

outlay

amount of money spent on something; payment

Aggregate Demand

Fiscal policy generally focuses on _

4.6%, 5%

During the Great Recession, unemployment went from to

Economic Stimulus Act of 2008

1 of the fiscal policy initiatives for the Great Recession; handed out tax rebates to taxpayers for them to spend, thereby increasing AD
(DECREASES TAXES)

American Recovery and Reinvestment Act of 2009

1 of the fiscal policy initiatives for the Great Recession; focused more on government spending; 70% govt spending, 30% tax credits
(INCREASED GOVT SPENDING)

budget deficit

Government spends more than it makes

budget surplus

Government makes more than it spends

borrowing

The government pays for the reduction/difference in tax revenue during a recession through __

increased budget deficits and national debt

Due to budget deficits from gov't. borrowing, expansionary fiscal policy leads to _ and __

contractionary fiscal policy

occurs when the gov't increases taxes or decreases spending to slow economic expansion
(DECREASES AD)

2 reasons to decrease AD

Reducing budget deficits & national debt; economy is expanding beyond long-run capabilities
(Why contractionary fiscal policy?)

countercyclical fiscal policy

fiscal policy that seeks to counteract business cycle fluctuations; uses expansionary policy during downturns and contractionary during expansions

multipliers

The initial spending effect of fiscal policy snowballs and ripples throughout the economy, generating income for everyone

Increased consumption

What is the effect of increased income on consumption?
(Multipliers key concept)

income for another

Spending by one person becomes….
(Multipliers key concept)

marginal propensity to consume (MPC)

The portion of additional income that is spent on consumption

change in consumption/change in income (C/Y)

MPC formula

spending multiplier

Determines the total impact on spending from an initial change of a given amount

mˢ = 1/(1 - MPC)

Spending multiplier (mˢ ) formula

spending multiplier

The bigger the MPC, the bigger the _

AKA spending multiplier

Keynesian multiplier, fiscal multiplier

time lags, crowding-out, saving shifts

The 3 shortcomings of (AD-focused) fiscal policy

recognition lag

The time it takes for policymakers to recognize the existence of a boom or downturn

implementation lag

The time it takes to pass and implement fiscal policies

impaction lag

The time it takes for the complete effects of fiscal or monetary policy to materialize

automatic stabilizers

Government programs that automatically implement countercyclical fiscal policy in response to economic conditions; reduces time lags

crowding-out

When private spending falls in response to increases in government spending

saving shifts

In response to increases in government spending or lower taxes, people may increase their current savings to help pay for inevitably higher future taxes

supply-side fiscal policy

Fiscal policy that uses government spending and taxes to affect the production (supply) side of the economy

new classical critique

asserts that increases in government spending and decreases in taxes are largely offset by increases in savings

supply-side policies

1. Increase incentives for productive activities

2. Each initiative takes time to take effect; seen as long-run solutions

increase

When tax rates are low, a(n) __ in rates -> increase in tax revenue

decrease

When tax rates are high, a(n) __ in rates -> increase in tax revenue

Laffer curve

Illustrates the relationship between tax rates and tax revenue

tax rate x income

Income tax revenue =

Region 1

Low tax rates; increase in tax rate -> increase in revenue

Region 2

High tax rates; increase in tax rate -> decrease in revenue (must cut taxes to progress economy)

t*

Maximum tax revenue on Laffer curve

supply-side

Tax rate cuts are generally _ fiscal policies

Liberals

Emphasize Region 1; increase tax rates to increase revenue

conservatives

Emphasize Region 2; decrease tax rates to increase revenue