Both expansionary and contractionary policies are examples of stabilization policies, actions to move the economy closer to full employment or potential output.
It is very difficult to implement stabilization policies for two big reasons:
Lags, or delays, in stabilization policy. Lags arise because decision-makers are often slow to recognize and respond to changes in the economy, and fiscal policies and other stabilization policies take time to operate.
Federal spending, spending by the U.S. government, consists of two broad components:
Discretionary spending constitutes all the programs that Congress authorizes on an annual basis that are not automatically funded by prior laws which includes defense spending and all nondefense domestic spending.
Entitlement and mandatory spending constitutes all spending that Congress has authorized by prior law.
Social Security provides retirement payments to retirees as well as a host of other benefits to widows and families of disabled workers.
Medicare provides health care to all individuals once they reach the age of 65.
Medicaid provides health care to the poor, in conjunction with the states.
Net interest is the interest the government pays on the government debt held by the public.
The deficit serves a valuable role in stabilizing the economy through three channels:
Automatic stabilizers: Taxes and transfer payments that stabilize GDP without requiring policymakers to take explicit action.
It was not until the presidency of John F. Kennedy during the early 1960s that modern fiscal policy came to be accepted.
Two factors lead to its support:
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