1. Chapter 15 Fiscal Policy

2. Demand-Side Economics
Until Great Depression, government did little to influence economy
persistent unemployment, low production changed many economists’ minds
John Maynard Keynes proposed Keynesian economics:
idea that during recession government should stimulate aggregate demand
basis of demand-side fiscal policy—policy to stimulate aggregate demand

3. Demand-Side Economics
Keynesian Theory
Changes in aggregate demand affect business cycle: GDP = C+I+G+F
GDP = consumer (C), investment (I), government goods (G), net exports (F)
exports small role in the economy; consumer, government spending stable
Keynes believed investment caused fluctuations in the economy
spending multiplier effect—a spending change results in larger GDP change

4. Government and Demand-Side Policies
The Role of Government
Depression economy stable, but high unemployment, little aggregate demand
Keynes argued for government spending to create jobs, increase income
also lower taxes to encourage consumer spending, business investment
During inflation Keynes favored decreased spending, raised taxes

5. Government and Demand-Side Policies
Sometimes demand-side policies work; example, World War II production
Difficult to discontinue popular programs after recession
Difficult for politicians to raise taxes during inflationary periods
Demand-side policies ineffective for stagflation
slow economic growth with unemployment and inflation

6. Supply-Side Economics
The Role of Government
Supply-side economists favor cutting individual, corporate taxes
to encourage people to work, save, invest more
reducing highest tax brackets frees income to most likely investors
Favor lower government spending: if need less revenue, can lower taxes
Favor less regulation: cuts production costs, ups aggregate supply

7. The Federal Deficit and Debt
All levels of government struggle to achieve balanced budget
Budget surplus occurs when government takes in more than it spends
Budget deficit occurs when government spends more than it takes in
Deficit spending—spending more than revenues for specific budget year
National debt—the total amount of money the government owes

8. The Federal Deficit and Debt
Causes of the Deficit
Four main reasons for deficit spending
— national emergencies usually require massive spending beyond normal budget
— building public goods and services is expensive, work takes years
— public projects to stimulate, stabilize weak economy need large sums
— entitlement programs that people depend on are expensive

9. The National Debt The Current Debt
In August 2006, national debt about $8.4 trillion
federal deficits and debt increased during 1980s, 1990s
since 1980s debt has grown faster than inflation—grown in real terms
In 1981, debt was 33 percent of GDP; in 2006 was nearly 68%
in 1981, about 80 percent privately owned; in 2006 less than 60% private

11. Is the Federal Deficit Too Large
Background pg. 370
Taxpayers ultimately pay the interest on the national debt, which is created by deficit spending by the federal government.
The government uses deficit spending for several reasons, including paying for national emergencies and implementing expansionary fiscal policies during periods of recession.
What’s the Issue
Is the federal deficit too large?
Thinking Economically (Documents: Sky Not Falling; Entitlement Issues; Dangers)
Identify the economic cause-and-effect relationships described in Documents A and C.
How does Document B illustrate the challenge facing the Bush administration in its efforts to carry out the plan discussed in Document C?
Do you think the Bush administration shares the concerns about the deficit expressed in Document A? Use information from the documents to explain your answer.