Fiscal PolicyFiscal Policy

Two types of fiscal policyTwo types of fiscal policy

Expansionary – increased spending Expansionary – increased spending or decreased taxesor decreased taxes

Contractionary – decreased spending Contractionary – decreased spending or increased taxesor increased taxes

Type of fiscal Type of fiscal policypolicy

Changes in Changes in government government spendingspending

Changes in Changes in taxestaxes

ExpansionaryExpansionary IncreaseIncrease DecreaseDecrease

ContractionarContractionaryy

DecreaseDecrease IncreaseIncrease

Crowding outCrowding out

Increased government spending Increased government spending doesn’t necessarily lead to increased doesn’t necessarily lead to increased total spendingtotal spending

Private spending may decreasePrivate spending may decrease

Complete crowding out means no Complete crowding out means no gain in total spendinggain in total spending

Crowding out could be incompleteCrowding out could be incomplete

John Maynard KeynesJohn Maynard Keynes

Too little spending = high Too little spending = high unemploymentunemployment

Previously economists thought Previously economists thought decreased spending = lower pricesdecreased spending = lower prices

Keynes said this wouldn’t happen Keynes said this wouldn’t happen because workers wouldn’t accept because workers wouldn’t accept lower wageslower wages

Therefore we needed expansionary Therefore we needed expansionary policiespolicies

Criticisms of KeynesCriticisms of Keynes

Doesn’t consider crowding outDoesn’t consider crowding out

Opened the door to government Opened the door to government intervention into the economyintervention into the economy

Crowding inCrowding in

Decreased government spending Decreased government spending doesn’t = decreased total spendingdoesn’t = decreased total spending

Crowding in can be complete or Crowding in can be complete or incompleteincomplete

Tax policiesTax policies

After-tax or disposable income = After-tax or disposable income = income left after taxes are paidincome left after taxes are paid

Lowering taxes = increased after-tax Lowering taxes = increased after-tax spendingspending

Raising taxes = decreased after-tax Raising taxes = decreased after-tax spendingspending

Supply sideSupply side

The lower the tax rate, the more The lower the tax rate, the more people are willing to workpeople are willing to work

This increases supplyThis increases supply

This helps the economyThis helps the economy

Tax cuts and tax revenuesTax cuts and tax revenues

Will cutting taxes decrease tax Will cutting taxes decrease tax revenues??revenues??

Lower taxes might lead to increased Lower taxes might lead to increased income since people are willing to income since people are willing to work morework more

This will actually increase tax revenueThis will actually increase tax revenue

PolicyPolicy Condition Condition existingexisting

Total Total spending spending affected?affected?

Policy Policy meet meet objective objective ??

Reduce Reduce unemploymeunemploymentnt

ExpansionarExpansionary policyy policy

No No CrowdingCrowding

outoutYesYes YesYes

Reduce Reduce unemploymeunemploymentnt

ExpansionarExpansionary policyy policy

CompleteComplete

CrowdingCrowding

OutOutNoNo NoNo

Reduce Reduce unemploymeunemploymentnt

ExpansionarExpansionary policyy policy

Incomplete Incomplete crowding crowding outout

YesYes YesYes

Reduce Reduce inflationinflation

ContractionaContractionary policyry policy

No No crowdingcrowding

ininYesYes YesYes

Reduce Reduce inflationinflation

ContractionaContractionary policyry policy

CompleteComplete

CrowdingCrowding

ininNoNo NoNo

Reduce Reduce inflationinflation

ContractionaContractionary policyry policy Incomplete Incomplete

crowding incrowding in YesYes YesYes