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Fiscal Policy

Fiscal Policy. Chapter 12. Stabilization. The United States government has 4 basic goals in terms of economic policy Full employment Price Stability High but sustainable growth Balanced Budget. Legislative Mandates. Employment Act of 1946

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Fiscal Policy

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  1. Fiscal Policy Chapter 12

  2. Stabilization • The United States government has 4 basic goals in terms of economic policy • Full employment • Price Stability • High but sustainable growth • Balanced Budget

  3. Legislative Mandates • Employment Act of 1946 • Congress proclaims government’s role in promoting maximum employment, production, & purchasing power • Creates Council of Economic Advisers • Report to the President • Joint Economic Committee of Congress to investigate economic problem of national interest

  4. Fiscal Policy & the AD/AS Model • Discretionary fiscal policy – Deliberate manipulation of taxes and spending by Congress – the economic options of the Federal government • Expansionary fiscal policy is needed to or used to combat recession

  5. Ways to fight recession • Increase government spending (shifts AD to the right) • Decrease taxes (shifts right) • Increased spending and reduced taxes • This will create a budget deficit assuming it was balanced to start

  6. Contractionary Fiscal Policy • What is Demand-Pull Inflation? • Fights by decreasing government spending. The goal is to reduce price levels but maintain GDP (output) • Increase taxes

  7. Financing Deficits • Borrowing – Government competes with private lending institutions for money. This however could drive up interest rates • Print Money – Federal Reserve loans directly to the US Government by purchasing bonds

  8. Disposing of Surpluses • Debt Reduction is good however it may cause interest rates to fall and spark inflation • Saving the surplus (Not bloody likely)

  9. Built In Stability • Arises because net taxes (minus transfer & subsidies) change with GDP. Spending needs to increase in a recession, decrease in an inflationary period • Taxes will automatically rise w/ GDP because incomes rise. In turn, they decrease when GDP falls • Transfers and subsidies rise when GDP falls

  10. Automatic Stabilizers • Depends on how progressive the corresponding tax system is. • Automatic stability reduces instability but does not correct economic instability • In other words, it will not prevent the problem from happening, but it will soften the blow when it does

  11. Problems of Timing • Recognition Lag – Elapsed time between beginning of a recession or inflation and awareness of the occurrence • Administrative Lag – Difficulty in changing policy once the problem has been recognized • Operational Lag – Difference in time between change in policy and its economic impact

  12. Political Considerations • Government has other goals other than economic stability and may conflict with stabilization. Examples? • How do election cycles affect economic policy? • State & Local finance policies may offset Federal efforts – Think Texas and its refusal of Federal stimulus funds

  13. Deficit Spending Problems • “Crowding Out” may occur w/ government deficit spending. • Deficit spending will lead to higher interest rates which weakens spending which could cancel out benefits of fiscal policy • Most economists argue that this will not occur during a recession

  14. Leading Indicators • Average workweek • Unemployment claims • Orders for consumer goods • Vendor performance • New orders for capital goods • Building permits for houses • Stock market prices • Money Supply • Interest Rates • Consumer Expectations

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