Fiscal Policy

© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair

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Prepared by: Fernando Prepared by: Fernando Quijano and Yvonn QuijanoQuijano and Yvonn Quijano

The Government andThe Government andFiscal PolicyFiscal Policy


Government in the EconomyGovernment in the Economy

• Nothing arouses as much controversy as Nothing arouses as much controversy as the role of government in the economy.the role of government in the economy.

• Government can affect the macroeconomy Government can affect the macroeconomy through two policy channels: fiscal policy through two policy channels: fiscal policy and monetary policy.and monetary policy.

• Fiscal policyFiscal policy is the manipulation of is the manipulation of government spending and taxation.government spending and taxation.

• Monetary policyMonetary policy refers to the behavior of the refers to the behavior of the Federal Reserve regarding the nation’s money Federal Reserve regarding the nation’s money supply.supply.


The Budget DeficitThe Budget Deficit

• A government’s A government’s budget deficitbudget deficit is the is the difference between what it spends (difference between what it spends (GG) and ) and what it collects in taxes (what it collects in taxes (TT) in a given ) in a given period:period:

B udget def G Ticit

• If If GG exceeds exceeds TT, the government must , the government must borrow from the public to finance the deficit. borrow from the public to finance the deficit. It does so by selling Treasury bonds and It does so by selling Treasury bonds and bills. In this case, a part of household bills. In this case, a part of household saving (saving (SS) goes to the government.) goes to the government.