Chapter_15.docx - Chapter 15 Fiscal Policy Fiscal Policy A....

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Chapter 15 Fiscal Policy Fiscal Policy A. What Fiscal Policy Is and What It Isn’t 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 are called fiscal policy . In the United States, the federal, state, and local governments all have responsibility for taxing and spending. B. Automatic Stabilizers versus Discretionary Fiscal Policy Some types of government spending and taxes that automatically increase and decrease along with the business cycle, are referred to as automatic stabilizers . The word automatic means that changes in spending and taxes happen without actions by the government. For example, when the economy is expanding and employment is increasing, government spending on unemployment insurance payments to workers who have lost their jobs will automatically decrease. C. An Overview of Government Spending and Taxes The size of the federal government expanded significantly during the Great Depression. As a fraction of GDP, the federal government’s purchases of goods and services have been declining since the Korean War in the early 1950s. Total expenditures by the federal government including transfer payments rose slowly from 1950 through the early 1990s and fell from 1992 to 2001, before rising again.
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Federal government expenditures include purchases plus all other federal government spending (e.g., transfer payments, defense spending, grants to state and local governments, interest payments, and other expenditures). The Effects of Fiscal Policy on Real GDP and the Price Level A. Expansionary and Contractionary Fiscal Policy: An Initial Look Decreasing government purchases or raising taxes can slow the growth of aggregate demand and reduce the inflation rate. Expansionary fiscal policy involves increasing government purchases or decreasing taxes. An increase in government purchases will increase aggregate demand. If the individual income tax is cut, household disposable income and consumption spending will rise. Tax cuts on business income can increase aggregate demand by increasing business investment. The goal of both expansionary monetary policy and expansionary fiscal policy is to increase aggregate demand relative to what it would have been without the policy. Contractionary fiscal policy involves decreasing government purchases or increasing taxes. Policymakers use contractionary fiscal policy to reduce increases in aggregate demand that seem likely to lead to inflation. Decreasing government purchases or increasing taxes can keep real GDP from moving beyond its potential level. B.
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This note was uploaded on 02/25/2010 for the course ECON 2010 taught by Professor Roussel during the Spring '08 term at LSU.

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Chapter_15.docx - Chapter 15 Fiscal Policy Fiscal Policy A....

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