1 Chapter 7 Fiscal Policy These slides supplement the textbook, but should not replace reading the textbook

2 Who were the Classical Economists? A group of the 18 th and 19 th centuries, including Adam Smith known as the father of modern day economics

3 What did Adam Smith and the Classical Economists believe? The economy was always tending toward a full employment equilibrium and stable prices

4 What does laissez-faire mean? Leave well enough alone, let the economy correct problems itself

5 What happened in the Depression of 1921? Even though it was serious the government practiced laissez-faire and the economy recovered in a short period of time

6 What were policies of President Herbert Hoover in the early 1930s to combat the depression?  public works projects  raised taxes  loans to failing firms  relief programs

7 What were policies of President Franklin Roosevelt in 1933 to combat the depression?  public works projects and social welfare programs  raised taxes and wages  loans to failing firms  relief programs

8 According to Robert Reich, an American political economist and professor, what was the result of these government programs? These programs helped save American capitalism

9 According to Thomas Woods author of Meltdown, what was the result of these government programs? These programs prevented the economy from seeking its equilibrium of full employment and prolonged the depression

10 What is a fiscal policy? The manipulation of government purchases, transfer payments, taxes, and borrowing in order to positively influence the economy

11 How did Keynes influence fiscal policies? He argued that fiscal policies may be necessary to bring about full employment

12 How did World War II affect fiscal policies? It showed that a government stimulus package can work

13 What is the Employment Act of 1946? Its main purpose was to lay the responsibility of economic stability of inflation and unemployment onto the federal government

14 What are the four phases of the business cycle? trough recovery peak recession

15 What are the 3 pillars of Keynesian Economics? Liquidity trap Balanced budget multiplier Paradox of thrift

16 What is a liquidity trap? A lack of borrowing keeps money bottled up in savings institutions

17 What is the Keynesian solution to a liquidity trap? Government borrows the money that consumers and business do not borrow

18 What is the Balanced Budget Multiplier? When the government taxes and spends the money there is a multiple effect because of no savings

19 What is the Paradox of Thrift? The more people save, the less will be demand, which leads to slow growth

20 What does crowding out mean? During periods of full employment the government can borrow money that otherwise would be spent or invested

21 How does the government borrow money? It sells bonds (securities) to the Fed or in the Open Market

22 What is the current national debt? Just over $17.5 trillion

23 What does monetizing the debt mean? The federal government sells bonds (securities) to the Fed and the Fed creates the money to buy the bonds

24 What can monetizing the debt lead to? A fall in the value of the dollar and inflation

25 What is a discretionary fiscal policy? Government policies that require ongoing decisions by policy makers

26 What are some examples of fiscal policies?  Government purchases  Transfer payments  Taxes

27 What are automatic stabilizers? Structural features of government spending and taxation smooth out fluctuations in booms and busts

28 What are some examples of automatic stabilizers?  Unemployment payments  Welfare  Other govt. programs

29 What is the point of Keynesian Economics? The economy could be stuck at equilibrium below the potential output for a prolonged period of time

30 What is an expansionary fiscal policy? An increase in government purchases, decrease in net taxes, or some combination of the two aimed at increasing aggregate demand

31 When would the government use expansionary fiscal policies? To stimulate the economy when unemployment is greater than the natural rate

32 What is a contractionary fiscal policy? A decrease in government purchases, increase in net taxes, or some combination of the two aimed at reducing aggregate demand

33 When would the government use contractionary fiscal policies? To slow down the economy when inflation is more than desired

34 What is the typical Keynesian policy during recessions? To use discretionary fiscal policies to stimulate the economy to a full employment equilibrium

35 What is the multiplier? Any change in the level of spending has a multiple effect on GDP

36 What is the accelerator? Any increase in spending can lead to an increase in secondary spending, for example, a new highway may lead to more restaurants, hotels, and gas stations

37 When does the accelerator have most impact on spending? During periods of full employment

38 How did World War II affect fiscal policies? It showed that a government stimulus package can work

39 What is MPC? The marginal propensity to consume (MPC) is a measure of how much consumers will spend out of any addition to their income

40 What is MPS? The marginal propensity to save (MPS) is a measure of how much consumers will save out of any addition to their income

41 If MPC is ¾, what is MPS? MPS would be ¼ because MPC + MPS = 1

42 What is the value of the multiplier? 1 / MPS

43 If MPC is ¾, what is the value of the multiplier? 1 / ¼ = 4

44 $ $75.00 $56.25 $42.19 $ $ original spent total money

45 What effect does an increase in demand have on prices and output? The more steeply sloped the supply curve the greater impact on prices and the less impact on employment

46 Slightly sloped Supply Curve Real GDP Price Level SRAS AD AD*

47 Steeply sloped Supply Curve Real GDP Price Level SRAS AD AD*

48 How effective are fiscal policies? Automatic stabilizers are more effective than are discretionary fiscal policies

49 Should we rely on automatic stabilizers? The stronger and more effective the automatic stabilizers are, the less need there is for discretionary fiscal policies

50 How effective were fiscal policies during the stagflation of the 1970’s? Whatever we did to fight one problem we made the other problem worse

51 What are lag effects?  Recognition lag  Decision lag  Action lag

52 Do lag effects influence discretionary fiscal policies? Yes, they weaken fiscal policies as a tool of economic stabilization

53 What is one’s permanent income? Income that individuals expect to receive on average over the long term

54 Do consumers base their decisions on their permanent income or their short term income? Perceived long term income

55 What is one thing policy makers often overlook? How fiscal policies unintentionally affect individual incentive to work, save and invest

56 What is the Laffer Curve? A curve that shows that starting from zero an increase in taxes will raise revenue but beyond a point an increase will lower revenues

57 What is the Laffer Curve?

58 What is supply side economics? The belief that real GDP can be increased by giving people incentives to work

59 What was fiscal policy in the Reagan Administration of the 1980’s? Taxes were decreased to stimulate the economy by increasing aggregate supply

60 What effect does politics have on fiscal policies? There is always the danger that politicians can use discretionary fiscal policies to suit their short term political goals

61 Does the federal deficit affect fiscal policies? If we were to increase spending by borrowing, the national debt could become unmanageable

62 Watch video on the National Debt ay?p=national+debt&n=21&ei=utf- 8&js=1&fr2=tab- web&tnr=20&vid=

63 What is the difference between a stock and a flow way of thinking? An example of a stock situation would be an increase in government spending has no opportunity costs

64 If we spend a dollar do we pay for that dollar here and now? Yes, either by higher taxes, higher interest rates if we borrow the money, or more inflation if we create the money

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