Chapter 11 - Congress to bring this about Any change in...

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CHAPTER SUMMARY Fiscal policy is the use of government purchases, taxes, and transfer payments for the purpose of stabilizing the macroeconomy. One needs to distinguish discretionary fiscal policy from the automatic stabilizers (non-discretionary fiscal policy). Expansionary fiscal policy (movement in the direction of a deficit) is recommended to combat a recession, whereas contractionary fiscal policy should be undertaken to combat inflation during an expansionary phase of the business cycle. The idea is to moderate changes in total spending (aggregate expenditures or aggregate demand). After all, it is changes in total spending which causes the business cycle. At least this is the Keynesian perspective. The presence of the automatic stabilizers helps to moderate the business cycle. Also, one can expect the automatic stabilizers to cause the deficit to rise during a recession and to fall when the economy expands. This happens without any direct action on the part of the President or
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Unformatted text preview: Congress to bring this about. Any change in total spending multiplied by the spending multiplier equals the change in nominal GDP. The spending multiplier equals the reciprocal of the marginal propensity to save (MPS). The tax multiplier equals one minus the spending multiplier. Therefore, any change in government spending has a more powerful impact on the economy than an equal but opposite change in taxes. Because of this, the balanced budget multiplier equals one. That is, an equal dollar change in government spending and taxes will change the equilibrium income level by the very same dollar amount. Supply-side fiscal policy argues that lower taxes encourage work, saving, and investment which shift the aggregate supply curve rightward. As a result, output and employment increase without inflation. Supply-side policy is based in part on the Laffer curve....
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