Fiscal Policy

• Fiscal policy


  The government's use of taxation and expenditure to influence the country's spending, employment and price levels
• Federal budget


  • The annual statement of the federal government's outlays and tax revenues
  • To finance the activities of the federal government
  • To achieve macroeconomic objectives
• Fiscal stimulus


  The use of fiscal policy to increase production and employment
• Types of fiscal stimulus

  • Automatic
  • Discretionary
• Automatic fiscal policy


  Fiscal policy action triggered by the state of the economy with no government action
• Discretionary fiscal policy


  Policy action initiated by an act of Congress
• Automatic changes in the federal budget

  • Tax revenues
  • Needs-tested spending
• Automatic changes in tax revenues

  Tax revenues depend on real GDP - increase in expansions, decrease in recessions
• Needs-tested spending


  Government transfer payments that depend on the economic state - decrease in expansions, increase in recessions
• Automatic fiscal stimulus


  • In recessions, receipts decrease and outlays increase, providing automatic stimulus
  • In booms, receipts increase and outlays decrease, providing automatic restraint
• Discretionary fiscal stimulus


  Focuses on its effects on aggregate demand
• Government expenditure multiplier


  Changes in government expenditure have multiplier effects on aggregate demand
• Tax multiplier


  Changes in taxes have multiplier effects on aggregate demand
• Expansionary fiscal policy


  Adopted to overcome unemployment or recession - increases public spending and reduces taxes
• Expansionary fiscal policy


  Increases aggregate expenditure and aggregate demand through the multiplier process
• Contractionary fiscal policy


  Adopted to overcome inflationary problems - creates a budget surplus to reduce aggregate spending
• Contractionary fiscal policy


  Decreases aggregate expenditure and aggregate demand through the multiplier process
• Crowding-out effect


  Increased public sector spending replaces or drives down private sector spending
• Causes of crowding-out effect

  • Government financing of projects with deficit spending increases interest rates, discouraging private spending and investment
  • Higher taxes for government social welfare programs leave less income for private charitable donations
  • Increased government spending on programs like Medicare decreases availability of private health insurance
• The use of discretionary fiscal policy is hampered by recognition lag, law-making lag, and impact lag