3.8-3.9 Fiscal Policy, Automatic Stabilizers

Fiscal Policy

the federal gov’s use of taxes and gov spending to affect the economy

Fiscal Policy Goals

1. increase GDP

2. lower unemployment

3. fight inflation

2 Tools in Fiscal Policy

Taxation

Government Spending

Discretionary Fiscal Policy

the actions taken by Congress and the President to correct economic issues like high inflation or high unemployment

involves active government response (voting on taxes/gov sp.)

Congress must pass legislation

Discretionary Fiscal Policy Types

1. Expansionary Fiscal Policy

2. Contractionary Fiscal Policy

Expansionary Fiscal Policy

help Recessionary Gap

increase AD thru inc gov spending or dec taxes

reduces unemployment

Lower Taxes OR higher gov sp → inc AD → higher PL → higher income/business profits → inc GDP

Contractionary Fiscal Policy

Congress uses this to dec AD and reduce inflation thru dec gov sp or inc taxes

when econ grows too rapidly, AD inc faster than SRAS, leading to demand-pull inflation and dec. value of dollars

Higher taxes OR lower gov sp → less income → dec AD → lower PL → lower inflation

Automatic Stabilizers

are non-discretionary fiscal policies that work automatically to steady the economy

use taxes and gov sp

do NOT need legislation; are built into our economic system

Types of Automatic Stabilizers

1. Public Transfer Payments

2. Progressive Income Taxes

Public Transfer Payments

ex. unemployment compensation, food stamps, welfare

lessen the effects of recessions

Progressive Income Taxes

as income increases, tax rate and amt taxes paid increases

limitations of fiscal policy

1. policy lags

2. timing issues

3. rational expectations theory

4. political issues

5. geography/regional issues