FISCAL POLICY

The Business Cycle

Stablization

Stablization Policy: Government policy designed to lessen the effects of the business cycle through expansionary policies and contractionary policies.

Policies

Expansionary: government policies designed to reduce unemployment and stimulate output

Contractionary: Government policies designed to stabilize prices and reduce output.

Expansionary

Gov’n increase purchases and raise injections to the circular flow. Reducing taxes have the same effect.

Contractionary

Government reduce the purchases and reduce injections. Raising taxes have same effect.

Government spending and taxing decisions are called fiscal policy and they have a significant impact on employment levels

automatic stabilizers – changes in G & T that occur automatically with changes in the economy (e.g. employment, income and output) that stabilize the economy

Fiscal Policy and Unemployment

discretionary fiscal policy – deliberate change in G & T by the gov’t attempting to stabilize the economy

tax leakage – a decrease in T slows this leakage

import leakage – an increase in taxes on imports slows this leakage

Fiscal Policy and Unemployment

government spending injection – an increase in G helps fill the bucket

export injection – subsidies and loans to exporting companies can help as can lower exchange rates for the Cdn. $

Fiscal Policy and Unemployment

Benefits of Fiscal Policy

Two benefits: Regional Focus Direct Impact on Spending

Regional Focus: Many regions can be affected more by business cycle thus discretionary fiscal policy can focus on particular regions.

Drawbacks of Fiscal Policy

Three Main drawbacks Delays Political Visibility Public Debt

Delays

Recognition Lag: Amount of time it takes policy makers to realize a policy is needed.

Decision Lag: Period that passes while an appropriate response is formulated and implemented.

Impact Lag: The time that elapses between implementing the policy and its having an effect on the economy.

Political Visbility

People respond usually to tax cuts and more government spending thus expansionary policy is good meanwhile if contractionary policies are needed. People don’t like them and politicians don’t want to use them.

Public Debt

Public Debt: Total amount of owed by federal government as a result of its past borrowing.

This will increase due to expansionary policies.

Multiplier Effect

Multiplier Effect: the magnified impact of a spending change on aggregate demand. E.g. Suppose gov’n institute an

expansionary fiscal policy. He pays Spender A $1000 for her services, and the Economy’s output rise by $1000 and the consultant’s revenue rises by $1000. This consultant spends half of she earns on Canadian product and the rest on savings. Thus she pays $500 to Spender B thus increasing spender B’s income. Thus the income has been expanded again by the $500.

Multiplier Effect

Important theory for Keyniasm. Explains the importance of government spending in the economy. This is to due with the increase of

disposable income towards consumption.