Fiscal Policy
Today’s LEQ: How do government
policies and actions impact economic
stability?
The Employment Act of 1946
• “The Congress hereby declares that it is the
continuing policy of the Federal Government
to use all practicable means… to promote
maximum employment, production, and
purchasing power.”
• Answer in your notes:
How does the Employment Act of 1946 relate
to Keynesian Economics?
Activity 1: U.S. Unemployment Rates &
the Federal Budget, 1928-1946
• Using the data on unemployment
over this period and your general
knowledge of history and economics,
answer the discussion questions.
Be ready to share!
What is Fiscal Policy?
• The use of government spending and
revenue collection to influence the
economy
– Specifically, to promote economic growth,
full employment, and price stability
• Every year, the gov’t decides how much
to spend and how much to tax
Expansionary Fiscal Policy
• Used to encourage growth when the
economy is in recession or to prevent
a recession
• Falls into either one or both
categories: increase gov’t spending
and cutting taxes
Increase in
Gov’t Spending
Cutting Taxes
Increases aggregate
demand & causes prices
to rise
Individuals have more
money to spend and
businesses keep more of
their profits.
Higher prices encourage
suppliers of g/s to
produce more
Consumers spend more
on g/s and firms have
more money to spend
on land, labor, and
capital.
Firms hire more workers
leading to lower
unemployment and
increase in output – the
economy EXPANDS!
These actions will
increase demand,
prices, and output – the
economy EXPANDS!
Contractionary Fiscal Policy
• Used to decrease growth
– For example, when fast-growing demand exceeds
supply, producers must choose – raise prices or
raise output
– Often leads to high inflation discouraging
economic growth and stability
• Falls into one or both of two categories:
decrease gov’t spending and raising taxes
Decreasing
Gov’t Spending
Increasing
Taxes
Decreases aggregate
demand b/c the gov’t
is buying less than
before.
Individuals have less
money to spend and
businesses keep less of
their profits.
Lower prices
encourage suppliers to
cut their production
and possibly let
workers go.
Consumers spend less
on g/s and firms have
less money to spend
on land, labor, and
capital.
Lower production
lowers the growth rate
- the economy
CONTRACTS!
These actions will
decrease demand,
prices, and output –
the economy
CONTRACTS!
Activity 2: Expansionary or
Contractionary Fiscal Policies? That is
the Question!
• In the situations provided, decide whether the
appropriate fiscal policy response is
expansionary (E), contractionary (C), or no
change (NC). Write E, C, or NC next to each
statement to indicate the policy you believe is
most appropriate.
Limits to Fiscal Policy
• Political Pressures: Candidates may not
always have the courage to do the right
thing when its unpopular with voters
Go back to Activity 2…
• Based on the situations provided, could
candidates win a national election by
supporting Keynesian discretionary policies?
• Go through each situation and decide yay or
nay and why
Limits to Fiscal Policy
• Time Lags: Congress and the President also
have to know when to implement fiscal
policies – Fiscal policy takes time!
– Recognition Lag
– Administrative Lag
– Operational Lag
Think of a red light…
Create your own analogy…
Limits to Fiscal Policy
• Predicting the Future: It’s difficult to know
current state of the economy. Business cycle
is unpredictable & politicians may put off
making changes in fiscal policy until more info
is available. By then it’s often too late 
Think of the idiot in the shower…
Create your own analogy…
Limits to Fiscal Policy
• Use pages 391 – 393 to fill out the
rest of the “limits to fiscal policy”
chart.
Be ready to share!
Automatic Stabilizers
• Not all fiscal policies are discretionary –
some are set up to stabilize the economy
automatically
• Most taxes and transfer payments (i.e.
social security, welfare, unemployment
compensation) are tied to GDP and
personal income, so they change
automatically
Examples Automatic Stabilizers
• Higher unemployment (contractionary phase)
 higher spending for unemployment
compensation & revenues from income taxes
automatically fall (automatic expansionary
stabilizer)
• Higher inflation (expansionary phase) 
wages and price levels rise & gov’t receives
more income and sales taxes (automatic
contractionary stabilizer)
Activity 3: Automatic Stabilizers
• Identify which of the policies listed there are
automatic fiscal stabilization policies
Activity 4: Memorandum from the
President of the United States
• Take on the role of the Council of Economic
Advisors (CEA) and prepare a report for
President Wynn on appropriate fiscal policy
actions, based on the economic data provided
in the handout.
Be ready to read your report to the class!
Exit Ticket
• Fiscal Policy & Monetary Policy
Review Questions