Fiscal Policy

Two types of fiscal policy Expansionary – increased spending or decreased taxes Expansionary – increased spending or decreased taxes Contractionary – decreased spending or increased taxes Contractionary – decreased spending or increased taxes

Type of fiscal policy Changes in government spending Changes in taxes ExpansionaryIncreaseDecrease ContractionaryDecreaseIncrease

Crowding out Increased government spending doesn’t necessarily lead to increased total spending Increased government spending doesn’t necessarily lead to increased total spending Private spending may decrease Private spending may decrease Complete crowding out means no gain in total spending Complete crowding out means no gain in total spending Crowding out could be incomplete Crowding out could be incomplete

John Maynard Keynes Too little spending = high unemployment Too little spending = high unemployment Previously economists thought decreased spending = lower prices Previously economists thought decreased spending = lower prices Keynes said this wouldn’t happen because workers wouldn’t accept lower wages Keynes said this wouldn’t happen because workers wouldn’t accept lower wages Therefore we needed expansionary policies Therefore we needed expansionary policies

Criticisms of Keynes Doesn’t consider crowding out Doesn’t consider crowding out Opened the door to government intervention into the economy Opened the door to government intervention into the economy

Crowding in Decreased government spending doesn’t = decreased total spending Decreased government spending doesn’t = decreased total spending Crowding in can be complete or incomplete Crowding in can be complete or incomplete

Tax policies After-tax or disposable income = income left after taxes are paid After-tax or disposable income = income left after taxes are paid Lowering taxes = increased after-tax spending Lowering taxes = increased after-tax spending Raising taxes = decreased after-tax spending Raising taxes = decreased after-tax spending

Supply side The lower the tax rate, the more people are willing to work The lower the tax rate, the more people are willing to work This increases supply This increases supply This helps the economy This helps the economy

Tax cuts and tax revenues Will cutting taxes decrease tax revenues?? Will cutting taxes decrease tax revenues?? Lower taxes might lead to increased income since people are willing to work more Lower taxes might lead to increased income since people are willing to work more This will actually increase tax revenue This will actually increase tax revenue

Policy Condition existing Total spending affected? Policy meet objective ? Reduce unemployment Expansionary policy No Crowding outYesYes Reduce unemployment Expansionary policy CompleteCrowdingOutNoNo Reduce unemployment Expansionary policy Incomplete crowding out YesYes Reduce inflation Contractionary policy No crowding inYesYes Reduce inflation Contractionary policy CompleteCrowdinginNoNo Reduce inflation Contractionary policy Incomplete crowding in YesYes