Unit 3 - Fiscal Policy

What is Fiscal Policy
Changes in the expenditures or tax revenues of federal government

Tools of fiscal policy

• Taxes - government can increase or decrease taxes
• Spending- government can increases or decreases spending

 Goal: To promote our nation's economic good: full employment, price stability, economic growth

Deficits, Surplus and Debt

Balance budget: Revenues = Expenditures

Budget deficit: Revenues < Expenditures

Budget surplus: Rvenues > Expenditures

Government debt: sums of all deficits

*Government must borrow money when it runs a budget deficit

Government borrows from
-Individuals
-Corporations
-Financial institutions
-Foreign entities or foreign government

Fiscal Policy Options

• Discretionary Fiscal Policy-think deficit
• Contractionary Fiscal Policy-think surplus
• Non-Discretionary Fiscal Policy (no action)

Discretionary vs. Automatic fiscal policies

Discretionary
-Increasing or decreasing government spending and/or taxes in order to return the economy to full employment
-Discretionary policy involves policy makers doing fiscal policy in response to an economic problem

Automatic
-Unemployment + compensation & marginal tax rates are examples of automatic policies that help mitigate the effect of recession and inflation. Automatic fiscal policy takes places with out policy makers having to respond to current economic problems

Contractionary vs. Expansionary

Contractionary
-Strategy to control inflation
-Decrease AD
-Decrease government spending
-Increase taxes

Expansionary
-Strategy to control recession
-Increase AD
-Increase GDP
-Reduce unemployment
-Increase government spending
-Decrease taxes


Automatic or Built- In stabilizers
Anything that increases the government increases its budget deficit during a recession and increases its budget surplus without requirement explicit action by policy makers.


Example: welfare check, food stamping, unemployment checks, corporate dividends, social security, veteran benefits, etc.

Economic Importance
- Taxes reduces spending and AD
- Reductions in spending are desirable when the economy is moving toward inflation
- Increases in spending are desirable toward recession

Tax System
Progressive: Average tax rate rises with GDP

Proportionary: Average tax rate remains constant as GDP changes

Regressive: Average tax rate falls as GDP changes

*Average tax rate = tax revenues / GDP