Fiscal Policy
Krugman Section 4
Modules 20 and 21
Fiscal Policy
Fiscal policy is done by CONGRESS—not
the Federal Reserve
Stabilization is done by G and Tax (T)
collection
Everything equal, what puts more money in the
economy, G or a decrease in T?
G! People can SAVE some of a tax break
The Employment Act of 1946
Congress proclaimed gov’t role in
promoting max. employment, production
and purchasing power
Keynesian Economics
Created the Council of Econ. Advisors to
advise the President
Created the Joint Economic Committee of
Congress to investigate econ. problems.
Discretionary Fiscal Policy
= changes to G or T are at the option of
Congress
Two types = expansionary and
contractionary
Expansionary Policy
Used to combat recession
Increase G
Decrease T
If budget is balanced, a budget deficit is
created
Goal is to shift AD to the right
LRAS
PL
SRAS
PL2
PL1
AD2
AD
Y1
Y2
GDPr
Contractionary Policy
Used to lower inflation
A decrease in G
An increase in T
Goal is to shift AD to the left by taking
money out of the system
PL
LRAS
SRAS
PL1
PL2
AD2
Y2
YI
AD
GDPr
Financing Deficit Spending
1. borrow from the public
Sell bonds to the public: take out loans
2. Money Creation
FED loans money directly to the gov’t
Could increase inflation
What to do with a Surplus
1. Pay off public debt
Buy back bonds
Puts $ back into the system, increases consumption
• May offset contractionary policy that created
the surplus
2. stand idle
Withholds purchasing power
No chance of inflation
Automatic Policy--Built In Stability
1. Income Tax
As income increases, people pay more taxes.
This limits the increase in DI and C.
2. Unemployment compensation
The income of unemployed does not fall to
zero. UC provides a base level of income.
3. Stocks and Bonds
Dividends do not follow the swings of the
business cycle. Bond payments are established
at the time the bond is purchased