Fiscal Policy

*The government has three roles in the economy: TAXATION, SPENDING, & REGULATION

Historically… Initially, the US government started with a _________________________ approach to business. However, after the ______________________________________, it was clear that the economy needed some guidance. LAISSEZ FAIRE GREAT DEPRESSION ; 11/22/2011.

So.. After _______________, the government decided they needed to take a _________________________ in the economy to regulate: UNEMPLOYMENT BUSINESS CYCLES INFLATION COST OF MONEY WWII PROACTIVE ROLE ; 11/22/2011. By using a mixture of both ___________________________ and _______________________ policies, governments are able to, in a sense, guide the economy, preventing major economic turmoil. Fiscal Monetary

What is it? Fiscal policy is the way governments adjust levels of ___________________ in order to ___________________ and _____________________ a nation's economy. It is the sister strategy to ____________________________ with which a ___________________________ influences a nation's money supply. These two policies are used to help guide a country to meet its _______________________________. SPENDING MONITOR INFLUENCE MONETARY POLICY CENTRAL BANK ECONOMIC GOALS

How does it work? It is based on the theories of British economist ____________________________. _________________________, states that governments can influence ____________________________________ levels by raising or lowering ____________________ and _________________________. This CAN curb ___________________ (generally considered to be healthy when at a level between 2-3%), decrease ______________________ and maintain the value of ___________. JOHN MAYNARD KEYNES KEYNESIAN ECONOMICS MACROECONOMIC PRODUCTIVITY TAX LEVELS PUBLIC SPENDING INFLATION UNEMPLOYMENT MONEY

AGGREGATE DEMAND: The sum of all demand in the economy

DISCRETIONARY FISCAL POLICY: Actions taken by the government by choice to correct economic instability; Congress must enact legislation in order for these policies to be implemented. (Similar to discretionary spending) EXPANSIONARY FISCAL POLICY: Plan to increase aggregate demand and stimulate a weak economy CONTRACTIONARY FISCAL POLICY: Plan to reduce aggregate demand and slow down an inflationary (too-rapidly expanding) economy

AUTOMATIC STABILIZERS: Features of fiscal policy that work automatically to stabilize the economy PUBLIC TRANSFER PAYMENTS PROGRESSIVE INCOME TAXES As income increases, so do taxes allowing it to be an automatic stabilizer Unemployment compensation, food stamps, welfare, etc.; when people receive these benefits, they gain income to spend so that recession is less severe on the individual/family. In a weak economy, more people qualify for these benefits; in a strong economy, less qualify

LIMITATIONS OF FISCAL POLICY: 1.It follows economic conditions and passing legislation takes time. 2.It should follow the business cycle to balance out peaks and troughs, but it is tough to predict. 3.Rational Expectation Theory-people and businesses expect fiscal policy to have certain outcomes. When they react to protect their interests, they may limit the effectiveness of the policy. 4.Political issues. (Council of Economic Advisers-advises president on fiscal policy, but they do not always follow because of political pressure.) 5.Regional issues.

DEMAND-SIDE ECONOMICS: FISCAL POLICY TO STIMULATE AGGREGATE DEMAND– KEYNESIAN ECONOMICS What was Keynes first revolutionary idea? He defined AGGREGATE DEMAND as the sum of investment, consumer spending, government spending, and net exports.

What did he propose the British government do in 1929? He proposed they spend money on public works projects to create jobs and ease unemployment.

What made Keynes question classical economics? The 1920’s going into the Great Depression and the cycle of demand falls, businesses produced less leading to layoffs, consumers had less money which led to falling demand…

Name two of his books: A Treatise on Money (1930) The General Theory of Employment, Interest, and Money (1936)

Keynes advocated increased government spending and decreased taxation to end recessions. INCREASED GOVERNMENT SPENDING CREATES JOBS INCREASES INCOME

Keynes advocated increased government spending and decreased taxation to end recessions. DECREASED TAXATION CONSUMERS SPEND MORE BUSINESSES INVEST MORE

Historically, when did this work? WWII However, this does not always work because excessive GOVERNMENT or CONSUMER spending can lead to INFLATION!!!

Cutting government spending is not always easy because people become RELIANT on these programs. Just like increasing taxes is not easy because politicians will often do what will WILL GET THEM RE-ELECTED as opposed to WHAT IS BEST FOR THE COUNTRY

During periods of STAGFLATION (slow economic growth with high unemployment and inflation) demand-side policies seem to be INEFFECTIVE

SUPPLY-SIDE FISCAL POLICY: Focuses on cutting the cost of production to encourage producers to supply more. SUPPLY-SIDE ECONOMISTS FAVOR: CUTTING TAXES ON INDIVIDUAL AND CORPORATE INCOME CUTTING IN THE HIGHER TAX BRACKETS GIVES MORE MONEY TO THOSE MOST LIKELY TO INVEST IN BUSINESS SPENDING CUTS-THE LESS THE GOVERNMENT SPENDS THE LESS TAXES NEED TO BE COLLECTED DECREASE GOVERNMENT REGULATION BECAUSE THESE ADD TO THE COSTS OF PRODUCTION

Laffer Curve Illustrates how tax cuts affect tax revenues and economic growth. Tax revenues increase as tax rates increase to a certain point. After that point, higher taxes actually lead to decrease tax revenue. WHY? Too high of taxes could actually discourage people from working, investing, and spending.

PROVING LAFFER’S THEORY: Legislation passed in the 1980’s CUT federal income tax rates substantially (top tax bracket from 70% to around 30%), however revenue collected from income tax INCREASED about 13%.

DISPROVING LAFFER’S THEORY: 1.With lower taxes people should work more as some did. However, some found they brought home the same amount of income from before the tax cuts by working less. 2.Lower tax rates should increase savings and investments, but savings declined during the 1980’s.