Fiscal Policy

What would you do with an unexpected $1,000 tax return?

Most people would spend at least part of it

What would you do if you owed an extra $1,000 in taxes?

People would reduce their consumption spending & save money to pay it

Fiscal Policy

the deliberate use of taxes and spending to influence the economy (speed it up or slow it down)

“Stimulus” money

For many years, people believed in classical economics

• laissez-faire = let things be

• supply and demand takes care of everything (remember the “invisible hand” theory proposed by Adam Smith)

• recessions and depressions would work themselves out

When did this change?

1930’s Great Depression changed everything

Unemployment was 25% in 1933 and never dropped below 14% the rest of the decade. . .the economy was not taking care of itself!

Recall: What is the unemployment % today?

John Maynard Keynes

British scholar who theorized that:• government should get involved• gov’t can control taxing and spending• the extremes of the business cycle could be

eliminated

His ideas are called Keynesian economics

Fiscal policy during recession

• Either increase gov’t spending or cut taxes– spending more on gov’t projects means more

jobs– cutting taxes for individuals means more

money for people to spend; cutting taxes for businesses means more capital investments or hiring more people

Fiscal policy during recession (cont.)

• With tax cuts & stimulus spending, recovery will occur

• This is called “Stepping on the gas”

Fiscal policy to prevent inflation

• Gov’t should decrease gov’t spending or raise taxes– (Opposite effects from the last slide of notes)

• This will slow economy down, and slow inflation

• This is called “Stepping on the brakes”

Online open note quiz