Fiscal Policy Unit 3

February 29, 2016

Fiscal Policy

Changes in the expenditures or tax revenues of the federal government.

2 tools of fiscal policy:

1. Taxes: government can increase or decrease taxes.

2. Spending: government can increase or decrease spending

Deficits, Surpluses, and Debt

• Balanced budget 

   Revenue=expenditures

• Budget deficit

   Revenue<expenditures

• Budget surplus

   Revenue>expenditures 

• Government debt

  (sum of all deficits - sum of all surpluses)

Government must borrow money when a budget deficit occurs:

1. Individuals
2. Corporations
3. Financial Institutions
4. Foreign Government

Discretionary Fiscal Policy (action): 

• Expansionary fiscal policy - think deficit
• Contractionary fiscal policy - think surplus

Non-discretionary fiscal policy (no action)

Discretionary vs. Automatic

Discretionary:

• Increasing or decreasing government spending and/or taxes in order to return the economy to full employment
• policy makers do fiscal policy in response to an economic problem

Automatic:

• Unemployment compensation and marginal tax rates are examples of automatic policies that help mitigate the effects of recession and inflation
• Takes place without policy makers having to respond to current economic problems

“Easy”  Expansionary Fiscal Policy	“Tight” Contractionary Fiscal Policy
·         Combats Recession ·         Increases Government Spending ·         Decreases Taxes	·         Combats Inflation ·         Decrease in Government Spending ·         Increase in Taxes

Automatic or Built in Stabilizers 

Anything that increase the government's budget deficit during a recession and increases its budget surplus during a inflation

• without requiring explicit action by policymakers

Ex: 

• Unemployment comp.
• welfare
• medicaid/medicare
• Social Security
• VA benefits

3 types of tax

Progressive Tax System:

• Average tax rate (tax revenue/GDP) rises with GDP

Proportional Tax System:

• Average tax rate remains constant as GDP changes

Regressive Tax System:

• Average tax rate falls with GDP

Economic Importance:

• Taxes reduce spending and aggregate demand
• reductions in spending are desirable when the economy is moving towards inflation
• increases in spending are desirable when the economy is heading toward recession