Economics BASIS 8 Unit 8 : Fiscal Policy

Unit 8A : Fiscal Policy

• Stabilization Policy—the use of government policy to reduce the severity of recessions and rein in excessively strong expansions.

  • Fiscal Policy—the federal government’s attempt to influence or stabilize the economy through taxation and government spending.

    • Discretionary fiscal policy is policy that someone must choose to implement. It requires an action by Congress, the president, or an agency of government to take effect.

    • An automatic stabilizer is a type of non-discretionary fiscal policy that automatically provides benefits to offset a change in people’s incomes.

• In times of recession, expansionary fiscal policy can be used to increase aggregate demand.

  • With expansionary policy the government has four options:

    • An increase in government purchases of goods and services

    • A decrease in taxes

    • An increase in government transfers, or

    • Any combination of the three.

  • best used during a recessionary gap

• During times of inflation, contractionary fiscal policy can be used to decrease aggregate demand.

  • With contractionary policy the government has four options:

    • A decrease in government purchases of goods and services

    • An increase in taxes

    • A decrease in government transfers, or

    • Any combination of the three.

  • best used during an inflationary gap

• Some taxes and transfers act as automatic stabilizers, meaning they reduce the size of fluctuations in the business cycle without requiring action by the president or Congress. 

• One of the main problems with discretionary fiscal policy is that it’s slow, which is commonly referred to as lag.

  • First, recognition lag is the time it takes for the government to recognize that a recessionary or inflationary gap exists.

  • Second, administrative (or legislative) lag is the time it takes the government to develop a spending or tax plan which is then debated and passed.

  • Third, operational (or implementation) lag is the time it takes for the policy to affect employment, price level, and output.

• The “crowding out” effect is the higher-than-normal interest rates caused by heavy government borrowing.

  • It can occur when the government borrows money to finance
    budget deficits, potentially leading to a decrease in consumption
    and investment.

Unit 8B : Government Budget & Debt

• The balance of the budget is simply the difference between the government’s tax revenue and its spending on both goods and services and on government transfers each year.

  • A budget surplus is a positive
    budget balance.

  • A budget deficit is a negative
    budget balance.

• A cyclically balanced budget aims to balance government revenues and expenditures over the entire economic cycle, allowing for deficits during downturns and surpluses during booms, rather than aiming for a balanced budget every single year.

• The problem is, governments are under considerable pressure to run deficits for fiscal policy and other reasons. 

  • Politicians will vote for deficit spending to satisfy the voters who elected them in the first place.

  • This is known as the political business cycle which results when politicians use macroeconomic policy to serve political ends.

• There are four major options with surpluses:

  • 1. Pay down the national debt

  • 2. Reduce taxes

  • 3. Increase government expenditures

  • 4. Increase the social security trust fund

• The national (or public) debt is the total amount of money the country owes to its creditors. 

• Demand-side policies are designed to increase or decrease total demand in the economy.

  • The philosophy is, that in order for economic growth to occur, it’s necessary for the government to use expansionary fiscal policy to maintain spending in the economy so that producers are willing to find ways to innovate, compete, and become more productive in the future

• Keynesian economics stand for any government spending or taxing policies designed to stimulate the private sector.

• Supply-side policies are government strategies aimed at boosting the economy's productive capacity and lowering unemployment. The focus is on increasing the supply of goods and services rather than stimulating demand.

• One goal of supply-side policies is to reduce government’s role in the economy. There are several ways to accomplish this goal, including

  • 1. reducing the number of federal agencies

  • 2. spending less at the federal level

  • 3. deregulation—the relaxation or removal of gov. regulations on business activities

• Another goal of supply-side policies is to lower business taxes