FISCAL POLICY

The Business Cycle

Stablization  Stablization Policy: Government policy designed to lessen the effects of the business cycle through expansionary policies and contractionary policies.

Policies  Expansionary: government policies designed to reduce unemployment and stimulate output  Contractionary: Government policies designed to stabilize prices and reduce output.

Expansionary  Gov’n increase purchases and raise injections to the circular flow. Reducing taxes have the same effect.

Contractionary  Government reduce the purchases and reduce injections. Raising taxes have same effect.

 Government spending and taxing decisions are called fiscal policy and they have a significant impact on employment levels  automatic stabilizers – changes in G & T that occur automatically with changes in the economy (e.g. employment, income and output) that stabilize the economy Fiscal Policy and Unemployment

 discretionary fiscal policy – deliberate change in G & T by the gov’t attempting to stabilize the economy  tax leakage – a decrease in T slows this leakage  import leakage – an increase in taxes on imports slows this leakage Fiscal Policy and Unemployment

 government spending injection – an increase in G helps fill the bucket  export injection – subsidies and loans to exporting companies can help as can lower exchange rates for the Cdn. $ Fiscal Policy and Unemployment

Benefits of Fiscal Policy  Two benefits:  Regional Focus  Direct Impact on Spending  Regional Focus: Many regions can be affected more by business cycle thus discretionary fiscal policy can focus on particular regions.

Drawbacks of Fiscal Policy  Three Main drawbacks  Delays  Political Visibility  Public Debt

Delays  Recognition Lag: Amount of time it takes policy makers to realize a policy is needed.  Decision Lag: Period that passes while an appropriate response is formulated and implemented.  Impact Lag: The time that elapses between implementing the policy and its having an effect on the economy.

Political Visbility  People respond usually to tax cuts and more government spending thus expansionary policy is good meanwhile if contractionary policies are needed. People don’t like them and politicians don’t want to use them.

Public Debt  Public Debt: Total amount of owed by federal government as a result of its past borrowing.  This will increase due to expansionary policies.

Multiplier Effect  Multiplier Effect: the magnified impact of a spending change on aggregate demand.  E.g. Suppose gov’n institute an expansionary fiscal policy. He pays Spender A $1000 for her services, and the Economy’s output rise by $1000 and the consultant’s revenue rises by $1000. This consultant spends half of she earns on Canadian product and the rest on savings. Thus she pays $500 to Spender B thus increasing spender B’s income. Thus the income has been expanded again by the $500.

Multiplier Effect  Important theory for Keyniasm. Explains the importance of government spending in the economy.  This is to due with the increase of disposable income towards consumption.