Notes

I. Expansionary Fiscal Policy A. Definition 1. Use of discretionary government spending or taxes to stabilize the economy. B. Types of Government Spending 1. Mandatory Spending - Automatic spending (e.g., Social Security, 63% of federal budget). 2. Discretionary Spending - Requires annual review (e.g., transportation, education, science). II. Effects of Aggregate Demand Changes A. Decline in aggregate demand 1. Leads to reduced output and increased cyclical unemployment. B. Expansionary fiscal policy effects 1. Increases government spending 2. Reduces taxes III. Tax vs. Government Spending Impact A. Depends on the marginal propensity to consume (MPC) and the multiplier B. Example 1. MPC = 0.75, MPS = 0.25, Multiplier = 4 (1/0.25) 2. $5 billion increase in spending can close a $20 billion gap 3. $6.67 billion tax cut necessary to yield the same result due to savings. IV. Consequences for the Federal Budget A. Balanced budget definition 1. Spending equals revenue. B. Expansionary fiscal measures 1. Create budget deficit (tax cuts/increased spending). 2. Government borrows to finance deficit via securities. V. National Debt A. Budget deficit contributions 1. Leads to the national debt, the cumulative amount borrowed by the government. VI. Contractionary Fiscal Policy A. Definition 1. Use of tax increase, reduction in government spending, or both to reduce an inflationary gap. B. Effects of aggregate demand increase 1. Inflationary gap increases output and prices (demand-pull inflation). C. Reduction in spending 1. Directly affects aggregate demand and must consider the ratchet effect. 2. Price levels tend not to come back down due to sticky wages and prices.