Chapter 12 Fiscal Policy

Fiscal policy
Changes in taxes and government
spending designed to affect
Aggregate Demand.
 Keynesian Economics
The idea that government fiscal
actions can stabilize the economy
gained acceptance during the Great
Depression (1929 1941).
 Employment Act of 1946
Government officially commits to
positive monetary and fiscal actions
to maintain economic stability.

Managing the economy will be the

responsibility of the President, his
Advisors, and Congress.
16th Amendment passed in
1913 makes Federal taxes
legal
Discretionary vs. Automatic
Discretionary fiscal policy decisions
must be made on when to use.

Automatic fiscal policy happens

without decision or vote.
 Types of Fiscal Policy
Expansionary increased
government spending, lower taxes or
a combination of both.

Contractionary lower government

spending, higher taxes or a
combination of both.
 Problems with fiscal policy
Time lags involved:
Recognition lag
Administrative lag
Operational lag
 Crowding out effect
Higher deficits lead to more
government borrowing. This drives
up interest rates. There is only so
much loanable money. If the
government sucks it all up, there is
none left for individual investors.
Political Business Cycle more
spending in election years, and
less in off years.
 Net Export Effect
By doing anything the government
makes the situation worse.
Recession => Expansionary Policy =>
More government borrowing => higher
interest rates => increased foreign
demand for dollars => value of dollar
goes up => net exports decline => GDP
goes down.
Implications of a large national
debt
National debt is currently $16. 7
trillion
$16,700,000,000,000.
How the money is borrowed.
Debt is sold by the U.S. government
in auctions every 3 months.
3 types of Securities are sold:
Treasury bills short term: 90 days, 180
days, 1 year
Treasury notes medium term: 1 -10
years
Treasury bonds long term: greater than
10 years.
 Who holds the U.S. Debt?
U.S. Government 52%
Foreign Governments 25%
State and Local Governments
Individual Investors
Insurance Companies
Banks and Credit Unions
 Foreign Ownership of U.S.
Debt
Japan
China
United Kingdom
OPEC Countries
 Primary problem of a large
debt
Interest payments must be made
annually out of Tax Revenues.
This leaves less money for health
care, national defense, social
security, etc.