Unit 3 - Fiscal Policy

Fiscal Policy

• changes in the expenditures or tax revenues of the federal government
• 2 tools of fiscal policy
• Taxes - government can increase or decrease taxes
• Spending - government can increase or decrease spending
• fiscal policy is enacted to promote our nation's economic goals; full employment, price stability, economic growth

Deficit, Surpluses, and 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
• government borrows from
• individuals
• corporations
• financial institutions
• foreign entities or foreign governments

Fiscal Policy Two Options

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

Discretionary v. 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 and marginal tax rates are examples of automatic policies that help mitigate the effects of recession and inflation. Automatic fiscal policy takes place without policy makers having respond to current economic problems.

Contractionary vs. Expansionary Fiscal Policy

• Contractionary Fiscal Policy - policy designed to decrease aggregate demand
• strategy for controlling inflation
• Expansionary Fiscal Policy - policy designed to increase aggregate demand
• strategy for increasing GDP, combating a recession, and reducing unemployment

Expansionary Fiscal Policy

• recession is countered with expansionary policy
• increase government spending (G↑)
• decrease taxes (G↓)

Contractionary Fiscal Policy

• inflation is countered with contradictory policy
• decrease government spending (G↓)
• increase taxes (G↑)

Automatic or Built-In Stabilizers

• anything that increases the government's budget deficit during a recession and increases its budget surplus during inflation without requiring explicit action by policymakers
• Transfer Payments:
• Welfare checks
• Food stamps
• Unemployment checks
• Corporate dividends
• Social security
• Veteran's benefits

Tax Systems

• Progressive Tax System
• average tax rate (tax revenue/GDP) rises with GDP
• Proportional Tax System
• average tax rate remains constant as GDP changes
• Regressive Tax System
• average tax rate falls with GDP