Richard Arana Andres Gomez Rodrigo Camacho Daniel Batista

 Stabilization Policy: is the use of government policy to reduce the severity of recessions and rein in excessively strong expansions.  “In the long run we are all dead.” Quote by Keynes that is usually interpreted as having recommended that governments not wait for the economy to correct itself.

 Reasons to maintain the economy at its original equilibrium.  Reason 1: The temporary fall in aggregate output that would happen without policy intervention is a bad thing, particularly because such a decline is associated with high unemployment.  Reason 2: Price stability is generally regarded as a desirable goal. So preventing deflation – a fall in the aggregate price level – is a good thing.

 Some policy measures to increase aggregate demand may have long-term costs in terms of lower long-run growth.  Because real world policy makers aren’t perfect, there is a danger that stabilization policy will do more harm than good.  Most economists believe that any short-run gains from an inflationary gap must be paid back later.

 In a negative supply shock, there are no easy remedies.  There are no government policies that can easily counteract the changes in production cost that shift the short-run aggregate supply curve.  Using monetary or fiscal policy to shift the aggregate demand curve in response to a supply shock causes two bad things to happen.

 Bad thing 1: A fall in aggressive output which leads to a rise in unemployment.  Bad thing 2: A fall in aggregate price level.  Any policy that shifts the aggregate demand curve helps one problem only by making the other problem worse.  Increasing aggregate demand reduces the decline in output but causes more inflation. Reducing aggregate demand curbs inflation but causes higher rise in unemployment.

 The U.S.’s government plays less of a role than other countries, such as Canada and European countries, but still plays enough of a role to be noticed.  Ex. Changes in federal budget can have large effects on the American economy.

 Funds flow into the government in the form of government borrowing, and the fund flow out in the form of government purchases of goods and services and transfers into households.  Overall, taxes on personal income and corporations accounted for 44% of total government revenue in 2008; social insurance taxes accounted for 27%; and a variety of other taxes, collected mainly at the state levels, accounted for the rest.

 (After the funds go in and the funds go out bullet point) The federal government relies on both personal income taxes, corporate profits, and social insurance taxes.  At the state and local levels, governments rely on a mix of sales taxes, property taxes, income taxes, etc.

 The other form of government spending is government transfers, or payments by the government to households for which no good or service is provided in return.  Government Transfers -Social Security: 15% -Medicare and Medicaid: 20% -Other Government transfers-9%  Government Purchases- -National defense: 13% -Education: 16% -Other goods and services- 27%

 Governmental programs that are designed to help families in times of economic hardship  Ex. Medicare, Medicaid, Social Security, Food Stamps, Unemployment insurance, etc.  Paid for by the insurance taxes.

 Government can affect government purchases of goods and services, consumer spending by an change in taxes and/or in government transfers, and investment spending by changing the rules that increase or reduce the incentive to spend of investment goods.  Because of this, the government can shift the aggregate demand curve.

 The government does this to either close a recessionary gap, when aggregate output falls below potential output, or an inflationary gap, when aggregate output exceeds potential output.  Expansionary Fiscal Policy increases aggregate demand by increasing government purchases of goods and services, cut in taxes, or an increase in government transfers.  Contractionary Fiscal policy decreases aggregate demand by deceasing government purchases of goods and services, raising taxes, or reducing government transfers.

 Economists argue that if the government were to try too hard to stabilize the economy through fiscal policies, it can cause the economy to become less stable.  One reason is the time lags associated with the fiscal policies.  These policies can take a long time to implement, months to years at each step of the process, such as collecting data and introducing a spending plan for the government.

 For example, by the time the government tries to fix a recessionary gap, the gap may have become an inflationary gap, causing colossal amounts of damage to the economy.