Fiscal Policy
Chapter 12
Stabilization
The United States government has 4 basic
goals in terms of economic policy
Full employment
Price Stability
High but sustainable growth
Balanced Budget
Legislative Mandates
Employment Act of 1946
Congress proclaims government’s role in
promoting maximum employment,
production, & purchasing power
Creates Council of Economic Advisers
Report to the President
Joint Economic Committee of Congress to
investigate economic problem of national
interest
Fiscal Policy & the AD/AS Model
Discretionary fiscal policy – Deliberate
manipulation of taxes and spending by
Congress – the economic options of the
Federal government
Expansionary fiscal policy is needed to
or used to combat recession
Ways to fight recession
Increase government spending (shifts AD
to the right)
Decrease taxes (shifts right)
Increased spending and reduced taxes
This will create a budget deficit assuming
it was balanced to start
Contractionary Fiscal Policy
What is Demand-Pull Inflation?
Fights by decreasing government
spending. The goal is to reduce price
levels but maintain GDP (output)
Increase taxes
Financing Deficits
Borrowing – Government competes with
private lending institutions for money. This
however could drive up interest rates
Print Money – Federal Reserve loans
directly to the US Government by
purchasing bonds
Disposing of Surpluses
Debt Reduction is good however it may
cause interest rates to fall and spark
inflation
Saving the surplus (Not bloody likely)
Built In Stability
Arises because net taxes (minus transfer
& subsidies) change with GDP. Spending
needs to increase in a recession,
decrease in an inflationary period
Taxes will automatically rise w/ GDP
because incomes rise. In turn, they
decrease when GDP falls
Transfers and subsidies rise when GDP
falls
Automatic Stabilizers
Depends on how progressive the
corresponding tax system is.
Automatic stability reduces instability but
does not correct economic instability
In other words, it will not prevent the
problem from happening, but it will soften
the blow when it does
Problems of Timing
Recognition Lag – Elapsed time between
beginning of a recession or inflation and
awareness of the occurrence
Administrative Lag – Difficulty in
changing policy once the problem has
been recognized
Operational Lag – Difference in time
between change in policy and its
economic impact
Political Considerations
Government has other goals other than
economic stability and may conflict with
stabilization. Examples?
How do election cycles affect economic
policy?
State & Local finance policies may offset
Federal efforts – Think Texas and its
refusal of Federal stimulus funds
Deficit Spending Problems
“Crowding Out” may occur w/ government
deficit spending.
Deficit spending will lead to higher interest
rates which weakens spending which
could cancel out benefits of fiscal policy
Most economists argue that this will not
occur during a recession
Leading Indicators
Average workweek
Unemployment claims
Orders for consumer goods
Vendor performance
New orders for capital goods
Building permits for houses
Stock market prices
Money Supply
Interest Rates
Consumer Expectations