Unit 3 Notes - February 29th, 2016 (and March 1st, 2016)

Fiscal Policy: Changes in the expenditures or tax revenues of the federal government.

2 Tools of Fiscal Policy

Taxes: Government can increase or decrease taxes

Spending: Government can increase or decrease spending.

Taxes and Spending share an inverse relationship. If one is increasing, the other is decreasing and vice versa.

Deficits, Surpluses, and Debt

Balanced Budget: Revenues = Expenditures

Budget Deficit: Revenues < Expenditures

Budget Surplus: Revenues > Expenditures

Government Debt: Sum of all deficits – Sum of all surpluses

The government must borrow money when it runs a budget deficit.

The government borrows from:

·         Individuals

·         Corporations

·         Financial Institutions

·         Foreign Entities or Foreign Governments

Fiscal Policy: Two Options

Discretionary Fiscal Policy (Taking Action)

·         Expansionary Fiscal Policy: Deficit

·         Contractionary Fiscal Policy: Surplus

Non-Discretionary Fiscal Policy (Not Taking Action)

Discretionary Fiscal Policy vs Automatic Fiscal Policy

Discretionary: Increasing or decreasing government spending and/or taxes in order to return the economy to full employment. Discretionary Policy involves policy makers doing fiscal policy in response to an economic problem. (Recession/Inflation)

Automatic: Unemployment, compensation, and marginal tax rates are examples of automatic policies that help mitigate the effects of recessions and inflation. Automatic fiscal policy takes place without policy makers having to respond to current economic problems.

Expansionary Fiscal Policy vs Contractionary Fiscal Policy

Expansionary (Easy):

·         Combats a recession

·         Increase in government spending

·         Decrease in taxes

Contractionary (Tight):

·         Combats inflation

·         Decrease in government spending

·         Increase in taxes

Automatic or Built-in Stabilizers: Anything that increases the government’s budget deficit during a recession and increases its budget surplus during inflation without requiring explicit action by policy makers.

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 towards a recession.

[March 1^st, 2016]

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.

The more progressive the tax system, the greater the economy’s built-in stability.