1. Fiscal Policy & Monetary Policy
I do not
set interest rates!
I’m in charge of
Taxes & Gov’t Spending
Fiscal Policy & Monetary Policy
Government Test Review

2. Business Cycle
Both Fiscal Policy & Monetary Policy attempt to “smooth” the “ups & downs” of the Business Cycle

3. AD/AS Model AD3 = UNEMPLOYMENT below
You draw the AD curve on 1-section of the
AS curve based on the economic situation
AD3 = UNEMPLOYMENT below
Full employment level (less than 4.5%)
GDP above speed limit
Inflation
AS1
AD1
AD3
AD2
AD2 = UNEMPLOYMENT 5%
GDP MODERATE
Not yet at “full employment”
Real
GDP
AD1 = RECESSION

4. Government Budget Know how the Government raises money for spending
which taxes supply the most money
Know top 4 major spending areas
Why entitlement spending is so dangerous
Why the Gov’t can’t balance the budget
The long term danger of a growing national debt

5. 2-Types of Deficits Structural deficit: a deficit which occurs with
the economy at full potential output (very high GDP)
Cyclical deficit: Portion of deficit attributable
to a slowdown in the business cycle (during recession)
Conclusion: Structural Deficits are significantly more problematic than Cyclical Deficits

6. Analyzing Deficits Summary
Debt & Deficit should be viewed as % GDP
This allows you to compare past deficits
Deficits can place upward pressure on long term interest rates
This is known as crowding out
The current Federal Deficit is a structural deficit
Entitlement spending must be addressed to correct it
TARP & Federal Stimulus will add 2 Trillion to our debt during 2009!
Debt could approach 100% of GDP in the next few years

7. FISCAL POLICY Monetary POLICY
RECESSION
FISCAL
POLICY
Monetary
POLICY
Expansionary
Contractionary
Loose
Tight
2 Types
2 Tools
Discount Rate
Open Market Operations
Taxes
Gov’t Spending
Recession = shift AD right
Too fast GDP = Shift AD Left
Goal
For both:

8. PROGRESSIVE U.S. Income Tax System
Understand the logic behind this cartoon and what it leaves out!

9. GDP What creates Economic Growth? INCENTIVES MATTER!!! GDP GDP
Classical, Keyensian and Supply Side Economists all
solve economic problems in different ways
(understand the key differences!)

10. Practice Free Response

11. Free Response Economic Scenario:
GDP growth is +6.0%, Unemployment 2%, Inflation is rising
Solve the economic problem using Monetary Policy:
Draw the graph of the current economy (AD/AS Graph)
Explain the type & details of Monetary Policy you would use
Graphically show the effect of your policy in the Money Market
Modify your AD/AS graph as a result of this change
Explain the effect of your policy on Employment
Explain the effect of your policy on Inflation

12. GDP growth at 6.0%, Inflation rising, Unemployment 2.0%
Economic Situation:
GDP growth at 6.0%, Inflation rising, Unemployment 2.0%
Solution: Tight Monetary Policy
MS1 MD
Interest
Rate
Qty of $
MS2
Inflation
Real
GDP
AS1
AD1
Affects AD
AD2 i2 i1
End Result: Lower GDP & less inflation!

13. Use Fiscal Policy to improve the economy
Economic Situation:
GDP growth at -1.0%, Inflation falling, Unemployment 8%
Use Fiscal Policy to improve
the economy
Inflation
Real
GDP
AS1
AD2
AD1
What type?
What Changes:
Taxes?
Gov’t Spending?
End Result: higher GDP & same inflation!