3. Fiscal Policy

Question 1

Counteract activity of fluctuations in a economic cycle
- Expansionary vs. Restrictive Policy
- Too fast or too slow
- Fiscal Tools: gov spend and taxes

Answer 1

Countercyclical Fiscal Policy

Question 2

Useful when economic output is too slow and unemployment is low

What to do? Decrease taxes and increase government spending in order to increase Agg. Demand

Goal? Increase economic growth and move back to full employment
- Basically putting more money into people’s hands to spend more

Leads to increase in budget deficit (-)

Answer 2

Expansionary Fiscal Policy

Question 3

Useful when economic output is too fast and inflation is high

What to do? Increase taxes and decrease government spending to decrease Agg. Demand

Goal? Slowing down economy buying reducing prices and inflation
- Basically put money in people’s hands to spend less

Leads to decrease in budget deficit (+)

Answer 3

Restrictive Fiscal Policy

Question 4

MPC = △consumption/△income

△ = subtract the 2 numbers

Answer 4

Marginal Propensity to Consume (MPC)

Question 5

MPS = △saving/△income

△ = subtract 2 numbers

Answer 5

Marginal Propensity to Save (MPS)

Question 6

ME = 1/(1-MPC)

• However much gov spends is ME (#) that amount
• Initial gov spending (G) x ME# = Y (income)
• Keynes because gov spending impacts the economy a lot

1 = MPC + MPS

Answer 6

Expenditure Multiplier

Question 7

People look at their income in the long run, not short run
- Unnecessary vs. necessary rather than effective vs. ineffective
- Classical because people are not animal spirits, they are calm

Answer 7

Permanent Income Hypothesis

Question 8

Classical view point
Trying to move economy back to stable but…

1. Dec taxes, inc gov spending
2. Inc demand for loanable funds
3. Inc interest rates
4. Dec Agg. Demand (-)

Answer 8

Crowding Out

Question 9

“Save the deficit” (Classical)

Answer 9

Ricardian Equivalence

Question 10

Time needed for policy makers to recognize issues
- Can be bad because some times these lags are not needed and makes the economy worse when it is already fixing itself

Answer 10

Recognition Lag

Question 11

Time needed for policy makers to change policy
- Can be bad because some times these lags are not needed and makes the economy worse when it is already fixing itself

Answer 11

Administrative Lag

Question 12

Time needed for the changed policy to impact economy
- Can be bad because some times these lags are not needed and makes the economy worse when it is already fixing itself

Answer 12

Impact Lag

Question 13

Fluctuations in economic activity without direct intervention by policymakers
- No laws or policies needed
- We have gov spending benefits (unemployment plans, etc.)
- No discretionary

Answer 13

Automatic Stablizers