Fiscal Policy – the use of tax policy and spending by the government to achieve some
macroeconomic goal. Typically, these policies target AD, but also the SRAS and LRAS curves.
Goals
o Boost output.
o Put people back to work.
o Mitigate inflation.
Implementing fiscal policy in an accurate and effective way is not as simple as pulling a couple
of levers and turning a few dials.
Automatic stabilizers
Tax revenues and transfer payments that automatically adjust to economic fluctuations without
action by Congress.
When the economy is growing
o Tax revenues rise.
o Transfer payments fall (fewer people require income assistance)
These effects temper the increase in economic output.
The opposite occurs when the economy begins slowing.
Discretionary spending – spending that works through the appropriations process in Congress
each year.
Mandatory spending – spending that is required by law. To adjust spending, congress must
change the law. Includes social security, Medicare, and interest on the national debt.
Public choice theory – the economic analysis of public and political decision-making, looking at
issues such as voting, election incentives, and the influence of special interest groups.
SUPPLY SIDE
The goal of supply-side fiscal policy is to promote growth, reduce unemployment, and stabilize
prices.
They are designed to shift the long-run aggregate supply curve to the right.
They do not always require a tradeoff between price levels and output.
They require more time to work than demand-side policies.
They tend to be more controversial than demand-side policies.
Examples
Spending on infrastructure, education, and technology.
Reducing business tax rates.
Expanding investment and reducing regulations.
These factors have helped to keep interest rates and inflation low for several decades.
The Laffer Curve
Arthur Laffer suggested that reducing tax rates could lead to increased tax revenues.
Lower taxes encourage people to work and encourage businesses to invest.
As investment grows, incomes rise, which leads to higher tax revenues.
Key questions:
o What is the optimal tax rate?
o Is maximizing tax revenues good for the economy?
Fiscal policy complications
Time lag
Information lag – most data that policymakers need are not available until at least one quarter
after the fact.
Recognition lag – it takes time to recognize trends in the data.
Decision lag – policies must be debated and passed in Congress and signed by the president.
Implementation lag – once a policy becomes law, it takes time to plan, budget, and implement
the new program.
How to finance fiscal policies – congress is extremely reluctant to raise taxes necessary to pay
for necessary spending increases or cut back on government spending programs.
Crowding out – active AD fiscal policies will increase the size of the government deficit, and this
will lead to an increase in interest rates, and this will lead to a decrease in private investment
spending.
Multiplier uncertainty combined with the lags means the implementation of fiscal policy is slow
and imprecise. Research shows multiplier is somewhere between .8 to 1.2. this does not mean we
should not implement fiscal policy.
Budget surplus – when tax receipts are greater than expenditures.
Budget deficit – when tax receipts are less than expenditures.
National debt – the total accumulation since beginning of the U.S of each annual deficit or
surplus
Debt ceiling – the max legal limit of the U.S debt, as set by congress.
Government budget constraints: G-T=change in M + change in B + change in A
M=money supply , B= bonds held by public entities, A= sales of government assets
