AP Review - Fiscal Policy and the Money Multiplier Flashcards
(17 cards)
Negative output gap
When a country is producing less than it can due to high unemployment
Positive output gap
When a country is producing more than it usually can due to unusually low unemployment
Fiscal policy
Government use of taxation and spending to stimulate the economy
Discretionary fiscal policy
Congress creates new bill designed to change AD through government spending/taxation
Non-discretionary fiscal policy (automatic stabilization)
Built in government mechanisms that help to stabilize the economy without new laws or policy change (progressive income tax, welfare spending)
Why is fiscal policy laggy?
- Recognition lag = Congress must react to the change in the economy
- Administrative lag = Congress takes time to pass legislation
- Operational lag = plan takes time to organize and execute
Contractionary fiscal policy
Fiscal policy to shrink the economy, decrease in government spending and/or increase in taxes
Expansionary fiscal policy
Fiscal policy to grow the economy, increase in government spending and/or decrease taxes
Crowding out
Fiscal policy crowds out investors by unintentionally raising interest rates
Multiplier effect
Shows how spending is magnified in an economy
Marginal propensity to consume (MPC)
(change in consumption) / (change in disposable income)
Marginal propensity to save (MPS)
(change in savings) / (change in disposable income)
Relation between MPS and MPC
MPS = 1 - MPC
Spending multiplier
1 / (MPS)
Tax multiplier
(MPC) / (MPS)
Total change in GDP
Spending multiplier * initial change in spending OR
Tax multiplier * initial change in taxes
Relation between tax multiplier and spending multiplier
tax multiplier = 1- spending multiplier
