Chapter 15 Fiscal Policy

1. Chapter 15 Fiscal Policy

2. Demand-Side Economics Until Great Depression, government did little to influence economy • persistent unemployment, low production changed many economists’ minds • John Maynard Keynes proposed Keynesian economics: • idea that during recession government should stimulate aggregate demand • basis of demand-side fiscal policy—policy to stimulate aggregate demand

3. Demand-Side Economics • Keynesian Theory • Changes in aggregate demand affect business cycle: GDP = C+I+G+F • GDP = consumer (C), investment (I), government goods (G), net exports (F) • exports small role in the economy; consumer, government spending stable • Keynes believed investment caused fluctuations in the economy • spending multiplier effect—a spending change results in larger GDP change

4. Government and Demand-Side Policies • The Role of Government • Depression economy stable, but high unemployment, little aggregate demand • Keynes argued for government spending to create jobs, increase income • also lower taxes to encourage consumer spending, business investment • During inflation Keynes favored decreased spending, raised taxes

5. Government and Demand-Side Policies • Demand-Side Policies • Sometimes demand-side policies work; example, World War II production • Difficult to discontinue popular programs after recession • Difficult for politicians to raise taxes during inflationary periods • Demand-side policies ineffective for stagflation • slow economic growth with unemployment and inflation

6. Supply-Side Economics • The Role of Government • Supply-side economists favor cutting individual, corporate taxes • to encourage people to work, save, invest more • reducing highest tax brackets frees income to most likely investors • Favor lower government spending: if need less revenue, can lower taxes • Favor less regulation: cuts production costs, ups aggregate supply

7. The Federal Deficit and Debt All levels of government struggle to achieve balanced budget • Budget surplus occurs when government takes in more than it spends • Budget deficit occurs when government spends more than it takes in • Deficit spending—spending more than revenues for specific budget year • National debt—the total amount of money the government owes

8. The Federal Deficit and Debt • Causes of the Deficit • Four main reasons for deficit spending — national emergencies usually require massive spending beyond normal budget — building public goods and services is expensive, work takes years — public projects to stimulate, stabilize weak economy need large sums — entitlement programs that people depend on are expensive

9. The National Debt • The Current Debt • In August 2006, national debt about $8.4 trillion • federal deficits and debt increased during 1980s, 1990s • since 1980s debt has grown faster than inflation—grown in real terms • In 1981, debt was 33 percent of GDP; in 2006 was nearly 68% • in 1981, about 80 percent privately owned; in 2006 less than 60% private

10. Is the Federal Deficit Too Large • Background • Taxpayers ultimately pay the interest on the national debt, which is created by deficit spending by the federal government. • The government uses deficit spending for several reasons, including paying for national emergencies and implementing expansionary fiscal policies during periods of recession. • What’s the Issue • Is the federal deficit too large? • Thinking Economically • Identify the economic cause-and-effect relationships described in Documents A and C. • How does Document B illustrate the challenge facing the Bush administration in its efforts to carry out the plan discussed in Document C? • Do you think the Bush administration shares the concerns about the deficit expressed in Document A? Use information from the documents to explain your answer.