1. Copyright © 2010 Pearson Addison-Wesley. All rights reserved. Chapter 13 Fiscal Policy

2. Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 13-2 Discretionary Fiscal Policy Fiscal Policy –The discretionary changes in government expenditures and/or taxes in order to achieve certain national economic goals, such as: High employment (low unemployment) Price stability Economic growth Improvement of international payments balance

3. Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 13-3 Discretionary Fiscal Policy (cont'd) An increase in government spending will stimulate economic activity Changes in government spending –Military spending –Education spending –Budgets for government agencies

4. Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 13-4 Discretionary Fiscal Policy (cont'd) Change in taxes –A rise in taxes causes a reduction in aggregate demand because it can reduce consumption spending, investment expenditures, and net exports.

5. Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 13-5 Possible Offsets to Fiscal Policy Fiscal policy does not operate in a vacuum and important questions must be answered. –How are expenditures financed and by whom? –If taxes are increased what does government do with the taxes? –What will happen if individuals worry about increases in future taxes?

6. Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 13-6 Possible Offsets to Fiscal Policy (cont'd) Crowding-Out Effect –The tendency of expansionary fiscal policy to cause a decrease in planned investment or planned consumption in the private sector; this decrease normally results from the rise of interest rates.

7. Copyright © 2010 Pearson Addison-Wesley. All rights reserved. 13-7 Figure 13-3 The Crowding-Out Effect, Step by Step