1. Aggregate Demand Policy in Perspective
Problems with Fiscal Policy

2. Laugher Curve Top Five Reasons to Study Economics
5. When you get drunk, you can tell everyone that you are just researching the law of diminishing marginal utility.

3. Laugher Curve Top Five Reasons to Study Economics
4. You can talk about money without having to make any.
3. You can say “trickle down” with a straight face.

4. Laugher Curve Top Five Reasons to Study Economics
2. When you are in the unemployment line, at least you know why you are there.
1. If you rearrange the letters in ECONOMICS, you get COMIC NOSE.

5. Supply Side versus Demand Side Policies
The interrelationship between AS and AD is captured in the circular flow diagram.
AS (production by firms) creates output and income, and hence AD (the potential demand to buy that output.

6. Supply Side versus Demand Side Policies
The AS/AD model separates long-run aggregate supply from short-run aggregate demand forces.
Demand-side policies (monetary and fiscal policy) shift the AD curve.
Supply-side policies work by increasing potential output.

7. Supply Side versus Demand Side Policies
Politicians are not constrained by models.
They can, and do, often emphasize different interconnections.

8. Demand-Side and Supply-Side Policies
Real output
Price Level
LAS
Supply-side policies shift the LAS curve.
SAS AD
Demand-side policies (monetary and fiscal policies) shift the AD curve YP

9. Problems with Fiscal Policy
Six assumptions of the AS/AD model lead to problems with fiscal policy:
Financing the deficit has no offsetting effects.
The government knows what the situation is.
The government knows potential income.
The government has flexibility in changing spending and taxes.
The size of the government debt doesn’t matter.
Fiscal policy doesn’t negatively affect other goals.

10. Financing the Deficit Doesn’t Have Offsetting Effects
Some economists believe that government financing of deficit spending offsets the deficit’s expansionary effect.
They believe that government borrowing increases interest rates and crowds out private investment.

11. Financing the Deficit Doesn’t Have Offsetting Effects
Crowding out – the offsetting of a change in government expenditures by a change in private expenditures in the opposite direction.

12. Financing the Deficit Doesn’t Have Offsetting Effects
Some economists argue that the effect of government expenditures is negative.
They consider private spending to be more productive than government spending.

13. Financing the Deficit Doesn’t Have Offsetting Effects
Crowding out also works in reverse in contractionary fiscal policy.
When the government runs a surplus, it buys back bonds.
Interest rates will drop, stimulating investment.

14. Partial Crowding Out Real output Price Level AD2 AD1 AD0 SAS
Net effect
Partial crowding out Y0 Y2 Y1

15. Knowing What the Situation Is
Data problems limit the use of fiscal policy for fine tuning.
Getting reliable numbers on the economy takes time.
We may be in the middle of a recession and not know it.

16. Knowing What the Situation Is
The government has large econometric models and leading indicators to predict where the economy will be in the near future.
Economic forecasting is still very much an art and not a science.

17. Knowing the Level of Potential Income
No one knows for sure the level of potential income.
Potential income has been called the full-employment level of income.

18. Knowing the Level of Potential Income
Differences in estimates of potential income often lead to different policy recommendations.

19. Knowing the Level of Potential Income
In most cases, the U.S. economy is in an ambiguous state.
Some economists will call for expansionary policy and others call for contractionary policy.

20. The Government’s Flexibility in Changing Taxes and Spending
Putting fiscal policy into place takes time and has serious implementation problems.
Numerous political and institutional realities in the U.S. today make it a difficult task to implement fiscal policy.

21. The Government’s Flexibility in Changing Taxes and Spending
Squabbles between Congress and the President may delay implementing appropriate fiscal policy for months, even years.

22. Size of the Government Debt Doesn’t Matter
These is no inherent reason why the adoption of activists policies should have caused high government deficits year after year.

23. Size of the Government Debt Doesn’t Matter
Activist policy has led to an increase in government debt because:
Early activists favored large increases in government spending as well as favoring the government's using fiscal policy.
Politically, it is much easier for government to increase spending and decrease taxes than vice versa.

24. Size of the Government Debt Doesn’t Matter
If one believes that debt is harmful, then there might be a reason not to conduct expansionary fiscal policy, even when the model calls for it.

25. Fiscal Policy Doesn’t Negatively Affect Other Government Goals
An economy has many goals – achieving potential income is only one of those goals
National economic goals often conflict.

26. Summary of the Problems
While the six problems listed above do not necessarily eliminate fiscal policy altogether, they severely restrict it.
Fiscal policy is a sledgehammer, not an instrument for fine-tuning.