This chapter explores the tools of government stabilization policy in terms of the aggregate demand-aggregate (AD-AS) model. Next, the chapter examines fiscal policy measures that automatically adjust government expenditures and tax revenues when the economy moves through the business cycle phases. The recent use and resurgence of fiscal policy as a tool are discussed, as are problems, criticism, and complications of fiscal policy. | Fiscal Policy, Deficits, and Debt 30 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. Fiscal Policy Deliberate changes in: Government spending Taxes Designed to: Achieve full-employment Control inflation Encourage economic growth LO1 30- Expansionary Fiscal Policy Use during a recession Increase government spending Decrease taxes Combination of both Create a deficit LO1 30- Expansionary Fiscal Policy Real GDP (billions) Price level AD2 AD1 $5 billion increase in spending Full $20 billion increase in aggregate demand AS $490 $510 P1 LO1 Recessions Decrease AD 30- Contractionary Fiscal Policy Use during demand-pull inflation Decrease government spending Increase taxes Combination of both Create a surplus LO1 30- Contractionary Fiscal Policy Real GDP (billions) Price level AD3 AD4 $3 billion initial decrease in spending Full $12 billion decrease in aggregate demand AS $502 $522 P2 AD5 $510 d b a P1 c LO1 30- Policy Options: G or T? To expand the size of government If recession, then increase government spending If inflation, then increase taxes To reduce the size of government If recession, then decrease taxes If inflation, then decrease government spending LO1 30- Built-In Stability Automatic stabilizers Taxes vary directly with GDP Transfers vary inversely with GDP Reduces severity of business fluctuations Tax progressivity Progressive tax system Proportional tax system Regressive tax system LO2 30- Built-In Stability G T Deficit Surplus GDP1 GDP2 GDP3 Real domestic output, GDP Government expenditures, G, and tax revenues, T LO2 30- Fiscal Policy: The Great Recession Financial market problems began in 2007 Credit market freeze Pessimism spreads to the overall economy Recession officially began December 2007 and lasted 18 months LO4 30- Problems, Criticisms, & Complications Problems of Timing Recognition lag Administrative lag Operational lag . | Fiscal Policy, Deficits, and Debt 30 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. Fiscal Policy Deliberate changes in: Government spending Taxes Designed to: Achieve full-employment Control inflation Encourage economic growth LO1 30- Expansionary Fiscal Policy Use during a recession Increase government spending Decrease taxes Combination of both Create a deficit LO1 30- Expansionary Fiscal Policy Real GDP (billions) Price level AD2 AD1 $5 billion increase in spending Full $20 billion increase in aggregate demand AS $490 $510 P1 LO1 Recessions Decrease AD 30- Contractionary Fiscal Policy Use during demand-pull inflation Decrease government spending Increase taxes Combination of both Create a surplus LO1 30- Contractionary Fiscal Policy Real GDP (billions) Price level AD3 AD4 $3 billion initial decrease in spending Full $12 billion decrease in aggregate demand AS $502 $522 P2 AD5 $510 d b a P1 c LO1 .
