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4.a) Fiscal Policy
Transcript of 4.a) Fiscal Policy
What is inflation?
Macroeconomics: The area of economics that addresses large-scale and general economic ideas ex) GDP, Inflation, unemployment, interest rates, taxes
Luckily there is a solution! Fiscal Policy
Discretionary Fiscal Policy
John Maynard Keynes
In 1936,John Maynard Keynes a famous british economist wrote a book called "The General Theory of Employment, Interest, and Employment" he believed that government involvement was crucial in an economy.
Fiscal Policy(4a)- Dilma, Krishtee, Garima
2 crucial Issues addressed in macroeconomics:
Potential Solutions: Monetary Policy, Fiscal Policy
To understand this idea here is an analogy...
we can think about inflation like slowing adding water to gasoline. At first you don’t notice and the value seems unchanged but soon the motor will begin malfunctioning and eventually stop working altogether. When the government prints more money but the amount of goods and services remain unchanged, the value of the dollar goes down and inflation occurs. Canada' s current annual inflation rate is just
1 % the lowest it has been since the recession.
In times of recession, the government's major concern is unemployment, in fiscal policy to help this the government would increase their spending (construction projects) to decrease unemployment
When aggregate demand is not able to catch up to
the aggregate supply there is a small shortage of jobs
but a surplus of workers therefore resulting in
the following graph illustrates this idea
Fiscal Policy: To remedy the macro economy, the government attempts to control the aggregate demand, with the tools of taxes, and government spending
To promote economic growth and be rid of inflation and unemployment, the government relies on the Federal Cabinet in the House of Commons as well as the approval of the Senate and Governor General to enforce Fiscal Policy.
Basic principle of Discretionary Fiscal Policy: The government uses their powers of government spending and tax rates to manipulate aggregate demand and therefore spending. If inflation and spending is high they will lower their spending and increase taxes so there is little buying power, if spending is low they will stimulate the economy and decrease unemployment with government spending and lowering tax rates so there is more buying power
Now you have a brief idea of fiscal policy, but a little review:
Expansionary Fiscal Policy
Expansionary Fiscal Policy: A macroeconomic policy intent on expanding the economy to reduce inflation and increase economic growth. Expansionary fiscal policy comes in the form of rebates, tax cuts, and increased government spending.
Like all policies, this one comes with both benefits and risks. It significant in managing low-growth periods in the business cycle (recessions) but economists must figure out when to increase the money supply to make sure high inflation doesn't occur.
Contractionary Fiscal Policy
Contractionary Fiscal Policy: A macroeconomic policy used when inflation and spending are high. This means that the government would LIMIT government spending,and INCREASE taxes so that there is little buying power (demand), thus inflation would be controlled.
This is used during high growth periods of the business cycle (peak/ later expansion phase) again to contract the economy,
To stimulate economic growth (by getting rid of unemployment and inflation) fiscal policy controls
government spending and taxes
There are two main categories:
expansionary fiscal policy
contractionary fiscal policy
his theory of fiscal policy is widely known across the globe
The following formula is a method of calculating GDP (aggregate expenditure):
AE = C + I + G
Aggregate Expenditure = Consumption Spending + Investment Spending + Government Spending
in the graph above to boost aggregate demand because of the unemployment and low spending the government has used expansionary fiscal policy
with government spending projects such as building roads they have decreased unemployment therefore allowing more people to increase their spending hence the shift in demand
the government also decreases taxes to further encourage spending
as a result the price level increases and in doing so inflation increases
the supply is merely showing that in the long run aggregate supply is more inelastic
contrastingly in this graph the government has used contractionary fiscal policy to decrease aggregate demand because of high inflation
the government would increase taxes and decrease government spending so that the demand would shift to the left
in doing so the price level decreases which means that inflation decreases
expansionary fiscal policy would be implemented during the recession phase of the business cycle to promote growth and encourage consumption by shifting aggregate demand
contractionary fiscal policy would be implemented during the peak period of the business cycle when inflation is too high
Monetary vs Fiscal Policy
control aggregate supply
drives interest rates up and down
exchanging of other currencies
promote economic growth
controls aggregate demand
drives taxes up and down
maintains price stability (inflation)
policy maker, Government
Economic Growth: An increase in the ability of an economy to produce goods and/or services in a given time period. A way to measure economic growth is to look at the level of inflation in the economy. When comparing the economic growth of two countries, GDP (gross domestic product) or GNP (gross national product) per capita is used because both formulas take into account the population difference between the countries.
The Application of Fiscal Policy
Debt vs Deficit
Money that is owed by the government
Three of several ways of stabilizing the macro economy without government intervention :
Corporate profits (taxes)
Progressive taxes (income)
The unemployment insurance program (transfer systems)
These take place during the recessions and expansions of the business cycle.
During boom times:
This automatic stabilizer increases the taxes on corporate profits
During times of recession:
During times of recession, taxes on corporate profits are decreased
They perform the same mechanics of fiscal policy though without government intervention.
During boom times:
progressive taxation pushes people into higher income tax brackets
increases tax bills
reducing government budget deficits (increasing government surplus
During a recession:
progressive taxation pushes people down into lower tax brackets
no income tax liability
increases government budget deficit (reduces budget surplus)
The UI Program
During boom times:
the Unemployment Insurance Program will automatically produce surpluses (which reduce deficits)
tax revenues increase due to the level of employment also increasing
During times of recession:
the program provides payment to people when unemployment levels increase
The difference between government expenditure and revenue in the given time frame of a year. Each year the total deficit is added to the national debt. In a recession the government will most likely be running a budget deficit as they lower taxes and increase spending (expansionary fiscal policy)
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Web. 06 Jan. 2014.
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Promoting economic growth with government involvement
Budget Surplus: government income-government spending
this is the opposite of budget deficit
when the government revenue or income exceeds the total government spending
when inflation is high there is a budget surplus as there is less government spending and an increase in taxes (contractionary fiscal policy)
Balanced Budget: Government revenue= government expenditure
when income is equal to expenditure the budget is balanced
the accumulated sum of the money the federal government owes, this includes budget deficit as well as other debts
to raise money for government spending the government also turns to bonds which sends us spiraling into deeper national debt
in 1980 America's national debt was 1 trillion and by 2009 the debt has reached 11,904,769,699,312.02 american dollars
The Perfect Economy
The government is attempting to keep the economy in the expansionary phase, where economic activity is always thriving but since this is not possible the best option is to keep it at a reasonable level which is achieved through fiscal policy.
Automatic Stabilizers: Policies or programs that are used as ways to sustain the economy, without government mediation.
Government expenditure- Government total income (taxes)