FISCAL POLICY

THE PRESIDENT AND CONGRESS USING TAXES AND SPENDING IN THE U.S. BUDGET TO INFLUENCE THE PATH OF THE ECONOMY

FATHER OF FISCAL POLICY: KEYNES

PRIOR TO KEYNES: RECESSIONS ARE SELF-CORRECTING

PRICES AND WAGES WILL , IN THE LONG RUN, FALL, AND THIS WILL STIMULATE A RECOVERY

KEYNES: “IN THE LONG RUN, WE ARE ALL DEAD”, MEANING COUNTRIES MAY NOT BE ABLE TO WAIT FOR A “NATURAL” RECOVERY

KEYNES – ECONOMY CAN FALL INTO A DOWNWARD SPIRAL

CONSUMERS REDUCE SPENDINGCOMPANIES SELL LESSCOMPANIES LAY-OFF WORKERSCONSUMERS HAVE LESS INCOMECONSUMERS REDUCE SPENDING MORECOMPANES SELL EVEN LESSCOMPANIES LAY-OFF MORE WORKERS

MAY TAKE YEARS FOR CYCLE TO BREAK

KEYNES – ONLY ENTITY BIG ENOUGH TO STOP THE FALL IS GOVERNMENT

GOVERNMENT TO USE ITS TAXING AND SPENDING POWER TO BREAK THE DOWNWARD CYCLE

IN A RECESSION: CUT TAXES AND INCREASE GOVERNMENT SPENDING – WILL GIVE CONSUMERS MORE SPENDING POWER AND GOVERNMENT SPENDING WILL LEAD TO MORE JOBS

THEN, WHEN THE RECESSION IS OVER

GOVERNMENT INCREASES TAXES AND REDUCES SPENDING

WILL KEEP THE ECONOMY FROM GROWING TOO FAST, WHICH MIGHT LEAD TO HIGHER INFLATION

ALSO ALLOWS DEBT TO BE REPAID

SO GOVERNMENT USES ITS BUDGET TO “LEAN AGAINST” THE BUSINESS CYCLE

“KEYNESIANISM” HAS BEEN EMBRACED

RICHARD NIXON: “WE ARE ALL KEYNESIANS NOW”

DURING RECESSIONS, FEDERAL GOVERNMENT ALWAYS TRIES TO CURTAIL IT

DIFFERENT PARTIES MAY EMPHASIZE TAX CUTS VERSUS SPENDING INCREASES

ISSUES WITH FISCAL POLICY, 1

OFTEN TAKES CONSIDERABLE TIME TO IMPLEMENT FISCAL POLICY

ARGUMENTS AMONG POLITICIANS ABOUT DETAILS

RECESSION MAY BE OVER BY TIME POLICIES ARE APPROVED

ISSUES WITH FISCAL POLICY, 2

IN RECESSION, THE TAX CUTS AND INCREASED SPENDING WILL LEAD TO MORE GOVERNMENT BORROWING AND A LARGER NATIONAL DEBT

KEYNES – DEBT WOULD BE PAID IN PROSPEROUS TIMES

BUT DIFFICULT FOR POLITICIANS TO DO

ISSUES WITH FISCAL POLICY, 3

IS IT EFFECTIVE – DOES IT WORK?

ISSUE – WHERE DOES THE MONEY COME FROM THAT THE GOVERNMENT SPENDS?

KEYNES – “IDLE RESOURCES” – CASH HELD IN POCKETS OF CONSUMERS, WHICH INCREASES DURING RECESSIONS

ONE SOURCE: BANK EXCESS RESERVES

ANOTHER SOURCE: FOREIGN FUNDS

BUT…..

IF FUNDS GOVERNMENT BORROWS TO SPEND WOULD HAVE BEEN SPENT BY BUSINESSES OR HOUSEHOLDS ON SOMETHING ELSE, THEN NO NET GAIN – “CROWDING OUT”

OR, IF BUSINESSES AND HOUSEHOLDS THINK THE BORROWING WILL LEAD TO HIGHER TAXES LATER, THEN THEY MAY REDUCE SPENDING NOW – WHICH OFFSETS THE GOVERNMENT SPENDING;CALLED “TAX DISCOUNTING”

ECONOMISTS ARGUE OVER THE “MULTIPLER” EFFECT OF FISCAL POLICY

MULTIPLIER – APPLY TO GOVERNMENT SPENDING TO GIVE TOTAL IMPACT ON THE ECONOMY EXAMPLE: MULTIPLIER OF “2” – MEANS GOVERNMENT SPENDING OF $1 BILLION HAS A $2 BILLION TOTAL IMPACT ON THE ECONOMY

IS MULTIPLIER LARGER THAN 1, 1, OR 0 – BIG DEBATE!!!

FISCAL POLICY IS VERY CONTROVERSIAL

SOME SAY GO BACK TO “PRE-KEYNES’ – LET ECONOMY HEAL “NATURALLY”

IF ACCEPT FISCAL POLICY – EMPHASIZE TAX CUTS OR GOVERNMENT SPENDING?

IS FISCAL POLICY EFFECTIVE – DOES IT DO ANYTHING?

WHICH IS STRONGER – MONETARY POLICY OR FISCAL POLICY?