Chapter 15 notes - Chapter 15 Fiscal Policy Fiscal Policy...

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Chapter 15 Fiscal Policy Fiscal Policy Fiscal Policy: changes in federal taxes and purchases that are intended to achieve macroeconomic policy objectives, such as high employment, price stability and high rates of economic growth. What Fiscal Policy Is and What It Isn’t? State and local governments will sometimes change their taxing and spending policies to aid their local governments, but these are not fiscal policy actions because they are not intended to affect the national economy. The defense and homeland security spending increases to fund the war on terrorism and the wars in Iraq and Afghanistan were part of defense and homeland security policy, not fiscal policy. Automatic Stabilizer Automatic Stabilizer : government spending and taxes that automatically increase or decrease along with the business cycle. o Automatic: changes in spending and taxes that happen without actions by the government. o Example: when the economy is expanding and employment is increasing, government spending on unemployment insurance payments to workers will automatically decrease. o When the economy is expanding and incomes increase, the amount governments will collect in taxes will increase. An Overview of Government Spending and Taxes Federal government purchases: buying aircraft carrier. Federal government expenditures: purchases plus all other government spending. Categories of government expenditures: o Purchases o Interest on the national debt: payments to holders of the bonds the federal government has issue to borrow money. o Grants to state and local governments: payments made by the federal government to support government activity at the state and local levels. Adding more police officers. o Transfer payments Social security, Medicare, unemployment payments, Food Stamps. The Future of Social Security and Medicare Currently there are only 3 workers per retiree. Federal spending on Medicare, Medicaid, and Social Security was 8.4% of GDP in 2005. Forecasts would be 14.3% in 2030 and 17.7% in 2050. The federal government raises about 40% of its revenue from individual income tax, 41% from social insurance taxes, 11% from corporate income taxes, and 8% from sales and other taxes. Using Fiscal Policy to Influence Aggregate Demand
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When the economy is in a recession, increases in government purchases or decreases in taxes will increase aggregate demand. Decreasing government purchases or raising taxes can slow the growth of aggregate demand and reduce the inflation rate. Expansionary Fiscal Policy Expansionary fiscal policy involves increasing government purchases or decreasing taxes. o An increase in government purchases will increase aggregate demand directly because government expenditures are a component of aggregate demand.
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