chapte15 - I. Fiscal Policy A. "Discretionary Fiscal...

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I. Fiscal Policy A. “Discretionary Fiscal Policy” refers to changes in G (government spending) or T (taxes) that result from a vote in Congress or an Executive order. These decisions target specific goals such as increasing employment or maintaining stable prices. B. “Automatic Stabilizers” are non-discretionary, built in adjustments to taxes and G that require no voting or new legislation. These changes in fiscal policy that automatically respond to fluctuations in economic activity can take the form of higher income tax rates in a boom and higher unemployment/ food stamps/ welfare (transfer) payments in a recession. While these policies help to stabilize income and employment, they are not significant enough to completely prevent periods of unemployment in recessions or inflation. C. “Compensatory Fiscal Policy” was what Keynes advocated. It can take the form of discretionary or non-discretionary policy, but what is key is that it compensates for the economy being in a situation with unemployment or inflation. This type of fiscal policy is used to restore Full-Employment GDP (starting in a recession). The use of Compensatory policy is to maintain price stability (in a boom). When fiscal policy is used in this counter-cyclical way, it is also called “functional finance.” II. Deficit Finance A. If G exceeds T (as it usually does in the US), the amount of G-T= deficit. If T exceeds G, T-G= surplus. A deficit is recorded for every year (calculated by the difference between the yearly outflows in gov’t spending and the yearly inflows of taxes) and rarely a surplus is recorded some years. Total all past deficits, minus all past surpluses, and the result is the national debt. B. Concerns about the deficits and the related debt include: i. Magnitude (size) of deficits and the debt have grown significantly in recent decades. Furthermore, with the baby boomer generation earning wages through recent decades, Social Security ran a surplus. When this demographic “swell” of citizens in a certain age group retires, the Social Security fund will be in a deficit. This is why many economists feel SS should be “off budget” because including the surplus of the SS fund makes the overall deficit seem not as severe. ii. The fraction of the total Federal Budget devoted to interest on the debt is gradually increasing. This is problematic because, while existing programs and new spending can be reduced in attempts to balance the Federal Budget, interest payments are non-discretionary. iii. Deficit timing is also a concern. In the past, deficits were used to pull the economy out of severe overcapacity (depression) or for urgent national security needs (WWII) but more recently deficits have existed while the economy was at or near full-employment. This is potentially inflationary (D-P inflation) iv. The “Crowding Out” is the reduction in private spending (C and/or I) that results from deficits pushing up interest rates. The reason deficits increase interest rates can be shown in the market for loanable funds;
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chapte15 - I. Fiscal Policy A. "Discretionary Fiscal...

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