Chapter 11

Chapter 11 - Fiscal Policy, Deficits, and Debt CHAPTER...

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Fiscal Policy, Deficits, and Debt CHAPTER ELEVEN FISCAL POLICY, DEFICITS, AND DEBT LECTURE NOTES I. Introduction A. Learning objectives – In this chapter the students will learn: 1. The purposes, tools, and limitations of fiscal policy. 2. The role of built-in stabilizers in moderating business cycles. 3. How the standardized budget reveals the status of U.S. fiscal policy. 4. About the size, composition, and consequences of the U.S. public debt. B. One major function of the government is to stabilize the economy (prevent unemployment or inflation). C. Stabilization can be achieved in part by manipulating the public budget—government spending and tax collections—to increase output and employment or to reduce inflation. D. This chapter will examine a number of topics. 1. It explores the tools of government fiscal stabilization policy using AD-AS model. 2. Both discretionary and automatic fiscal adjustments are examined. 3. The problems, criticisms, and complications of fiscal policy are addressed. 4. The size of and concerns about the public debt are identified and explored. II. Fiscal Policy and the AD/AS Model A. Discretionary fiscal policy refers to the deliberate manipulation of taxes and government spending by Congress to alter real domestic output and employment, control inflation, and stimulate economic growth. “Discretionary” means the changes are at the option of the Federal government. B. Discretionary fiscal policy changes are often initiated by the President, on the advice of the Council of Economic Advisers (CEA). C. Changes not directly resulting from congressional action are referred to as nondiscretionary (or “passive”) fiscal policy. D. Fiscal policy choices: Expansionary fiscal policy is used to combat a recession (see examples illustrated in Figure 11.1). 1. Expansionary Policy needed: In Figure 11.1, a decline in investment has decreased AD from AD 1 to AD 2 so real GDP has fallen and also employment declined. Possible fiscal policy solutions follow: a. An increase in government spending (shifts AD to right by more than change in G due to multiplier), b. A decrease in taxes (raises income, and consumption rises by MPC change in income; AD shifts to right by a multiple of the change in consumption). c. A combination of increased spending and reduced taxes. d. If the budget was initially balanced, expansionary fiscal policy creates a budget deficit. 165
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Fiscal Policy, Deficits, and Debt 2. Contractionary fiscal policy needed: When demand-pull inflation occurs as illustrated by a shift from AD 3 to AD 4 up the short-run aggregate supply curve in Figure 11.2. Then contractionary policy is the remedy: a. A decrease government spending shifts AD 4 back to AD 3 once the multiplier process is complete. Here price level returns to its preinflationary level P 3 but GDP returns to its noninflationary full-employment level of output ($510 billion). b.
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Chapter 11 - Fiscal Policy, Deficits, and Debt CHAPTER...

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