Fiscal Policy

Fiscal Policy Fiscal: refers to anything related to gov’t revenue, spending & debt. Fiscal Policy: the federal gov’t use of taxes & gov’t spending to affect the economy. To stabilize the economy, the gov’t can use 1 of 2 basic policies: expansionary fiscal policy or contractionary fiscal policy Gov’t has 2 basic fiscal tools to influence the economy: taxation & gov’t spending.

II. Discretionary Fiscal Spending & Automatic Stabilizers Discretionary Fiscal Spending: involves actions taken by the gov’t by choice to correct economic instability. Automatic Stabilizers: policy features that work automatically to steady the economy. Public Transfer Payments: programs like unemployment, food stamps etc. These payments automatically set up a flow of money into the economy During a recession many ppl are unemployed and qualify to unemployment benefits. They get money that they will then spend, money gets put into the market. When the economy improves, ppl will go back to work, get off unemployment & gov’t spending will decrease.

III. Expansionary Fiscal Policy Def: a plan to increase aggregate demand and stimulate a weak or slow economy. Remember, increased aggregate demand causes prices to rise, providing incentives for businesses to expand and causing GDP to increase. Ex: New Jobs: The economy is in a recession and in response the gov’t decides to increase spending for highways. Workers are hired to fix, expand the highways. Those workers have $ to spend in the market. Ex: Cut Taxes: By cutting income and/or corporate taxes, the gov’t allows ppl and businesses to have more income after taxes, which they will spend in the economy.

IV. Contractionary Fiscal Policy Def: a plan to reduce aggregate demand and slow the economy in a period of too-rapid expansion. Used to reduce inflation. When a country is growing too rapidly, aggregate demand may increase faster than aggregate supply, leading to demand-pull inflation. Gov’t may choose to decrease gov’t spending or increase taxes in order to control inflation.

By cutting spending, the gov’t takes $ out of the economy, which results in less income for ppl. They will have less $ to spend on goods/services and aggregate demand decreases. As aggregate demand decreases, the rise in the price level is stopped and inflation is brought under control. By increasing taxes, you will cut consumer spending and therefore slowdown the rate of inflation.