Unit Three: Fiscal Policy

Fiscal Policy

Notes from 2/29/16

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

2 Tools of Fiscal Policy

     -Taxes: Government can either increase or decrease taxes

     -Spending: Government can either increase or decrease taxes

DEFICIT, SURPLUS, DEBT

-Balanced Budget- Revenues = Expenditures

-Budget Deficit- Revenues < Expenditures

-Budget Surplus- Revenues > Expenditures

-Government Debt- Sum of All Deficits - Sum of All Surpluses

• Government must borrow money when it runs a deficit from:
• Individuals (Taxes)
• Corporations
• Financial Institutions
• Foreign Entities/ Foreign Governments

2 Options

1. Discretionary Fiscal Policy (ACTION)
1. Expansionary
2. Contractionary
2. Non-Discretionary Fiscal Policy (NO ACTION)

DISCRETIONARY

-Increasing or decreasing government spending and/or taxes in order to return the economy to full employment.

-Involves policymakers doing fiscal policy in response to an economic problem (recession)

AUTOMATIC

-Unemployment compensation and marginal tax rate are examples of policies because they mitigate the effects of recession and inflation.

-Takes place without policymakers having to respond to economic problems

EXPANSIONARY

-Combats a recession

-INCREASE government spending 

-DECREASE taxes

CONTRACTIONARY
-Combats inflation

-DECREASE government spending

-INCREASE taxes

AUTOMATIC or BUILT-IN STABILIZERS 

-Anything that increases the governments budget deficit during a recession and increases its budget surplus during inflation without requiring explicit action by policymakers.

-Economic Importance:

    +Taxes reduce spending and AD
    +Reductions in spending are desirable when the economy is moving toward inflation

    +Increases in spending are desirable when the economy is heading toward recession

    +Examples: Medicare, Medicaid, Social Security

TAXES

1. Progressive Tax System- Average tax rate rises with GDP
2. Proportional Tax System- Average tax rate remains constant as GDP changes
3. Regressive Tax System- Average tax rate falls with GDP

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