FISCAL POLICY
CHAPTER 13
The GDP Bucket
Y = INCOME
Q = OUTPUT
E = EMPLOYMENT

PROBLEM 1: RECESSION “Man The Pumps! Control the Leaks!”
Y Q E

PROBLEM 2: INFLATION “Stop the Pumps! Open the Leaks!”
Y
Q
E

John Maynard Keynes
The Economy can be like an elevator…
In a Recession, it gets stuck at the bottom.(JMK)
How do you get the elevator to rise to the correct level?
PROBLEM 1: RECESSION “Man The Pumps! Control the Leaks!”
Y Q E

Whose money? Where does it come from?
1. Consumers? No.
Slow to spend. UR rising in a recession
2. Businesses? No.
Sales and Investment spending is slowing
3. Banks? No.
Unwilling to lend if C and B not spending
4. GovernmentBorrow! Borrow! Borrow!
G > T
Active Fiscal Policy
Use of government expenditures and taxes to reach specific macroeconomic goals:
Full Employment
Stable Prices
Economic Growth
FISCAL POLICY
How it is supposed to work…
“Use of government expenditures and taxes to reach specific macroeconomic goals”
If there is a recession…
A tax cut
and/or
increased government spending
[See Text, p. 299, Table 13.1]
Fiscal Policy Methods
Expansionary
Active increases in government spending and/or tax decreases
To increase real output, employment and incomes
Contractionary
Active decreases in government spending and/or tax increases
To decrease real output, employment and incomes
The Business Cycle Model
Peak

Recovery Recession

TroughTrough
Business Cycle w/ Fiscal Policy“Control the Pumps! Watch the Leaks!”

Peak
Recovery Recession

The AD/AS Model
Recession AS
PL
AD1 (C+I+G)
AD (C+I+G)
Q

Problems of Fiscal Policy
Time Lags
To decide tax cut? Spend more? How much?
To take effect through economy
Crowding Out
More borrowing by Gov’t, by selling bonds
Attract Investors… Investors not seek other investments …{See leakages in the Leaky…