1. FISCAL
POLICY

2. LEGISLATIVE MANDATES
Employment Act of 1946
Council of Economic
Advisors (CEA)
Joint Economic
Committee (JEC)

3. FISCAL POLICY AND THE AD-AS MODEL
Two Options
• Discretionary Fiscal Policy
• Non-Discretionary Fiscal
Policy
Expansionary Fiscal Policy
To Reduce Unemployment…
• Increase Government
Spending
• Tax Reductions
• Combinations of the Two

4. Pricelevel
Real GDP (billions)
EXPANSIONARY FISCAL POLICY
Full $20 billion
increase in
aggregate
demand
AD2 AD1
$5 billion initial
increase in spending
the multiplier at work...
P1
$490 $510
AS

5. To Reduce Inflation…
• Decrease Government
Spending
• Tax Increases
• Combinations of the
Two
FISCAL POLICY AND THE AD-AS MODEL
Contractionary Fiscal Policy

6. Pricelevel
Real GDP (billions)
CONTRACTIONARY FISCAL POLICY
Full $20 billion
decrease in
aggregate
demand
AD3 AD4
$5 billion initial
decrease in spending
the multiplier at work...
P2
$510 $522
AS
P1

7. FINANCING OF DEFICITS AND
DISPOSING OF SURPLUSES
•Borrowing vs. New Money
•Borrowing From The Public
•Money Creation
•Debt Retirement vs. Idle Surplus
•Debt Reduction
•Impounding
Which Policy Option?
G or T?

8. BUILT-IN STABILITY
Net tax revenues vary
directly with GDP
Transfer payments behave
the opposite way as tax
collections
Automatic or Built-In
Stabilizers
Economic Importance

9. BUILT-IN STABILITY
GDP1 GDP2 GDP3
Real Domestic Output, GDP
GovernmentExpenditures,
G,andTaxRevenues,T
Deficit
Surplus
T
G

10. BUILT-IN STABILITY
Tax Progressivity
• Progressive Tax System
• Proportional Tax System
• Regressive Tax System
The more progressive the
tax system, the greater the
economy’s built-in stability.

11. FULL-EMPLOYMENT DEFICITS
GDP2 GDP1
Real Domestic Output, GDP
GovernmentExpenditures,
G,andTaxRevenues,T(billions)
G
T1
(Year 1)(Year 2)
ab
c
$500
475
450
425
No Change in
Fiscal Policy

12. FULL-EMPLOYMENT DEFICITS
GDP4 GDP3
Real Domestic Output, GDP
GovernmentExpenditures,
G,andTaxRevenues,T(billions)
T2
G
T1
Year 3Year 4
de
f
$500
475
450
425
Discretionary
Fiscal Policy
Tax Decrease
h
g

13. EVALUATING FISCAL POLICY
Full-Employment Budget
Cyclical Deficit
Recent U.S. Deficits & Surpluses
Year
Actual
Deficit or
Surplus
Full-Employment
Deficit or
Surplus
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
-3.9%
-4.5%
-4.7%
-3.9%
-2.9%
-2.2%
-1.4%
-0.3%
+0.8%
+1.4%
+2.4%
+1.3%
-1.5%
-2.1%
-2.4%
-2.9%
-2.8%
-2.1%
-2.0%
-1.3%
-0.9%
-0.4%
+0.3%
+1.1%
+0.8%
-1.5%

14. -6 -4 -2 0 2 4
Italy
Sweden
Canada
United Kingdom
France
United States
Ireland
Norway
Japan
GLOBAL PERSPECTIVE
BUDGET DEFICITS OR SURPLUSES
AS A PERCENTAGE OF GDP, 2002
Source: Organization for Economic Development and Cooperation

15. PROBLEMS, CRITICISMS,
AND COMPLICATIONS
•Problems of Timing
•Recognition Lag
•Administrative Lag
•Operational Lag
•Political Considerations
•Political Business Cycles
•Offsetting State & Local
Finance
•Crowding-Out Effect

16. FISCAL POLICY, AGGREGATE
SUPPLY AND INFLATION
Fiscal Policy:
No Complications
Pricelevel
Real GDP (billions)
AD1 AD2
P1
$490 $510
AS

17. FISCAL POLICY, AGGREGATE
SUPPLY AND INFLATION
Fiscal Policy:
Showing
Crowding-out Effect
or Net Export
Effect
Pricelevel
Real GDP (billions)
AD1 AD2
P1
$490 $510
AS
AD’2
$504

18. FISCAL POLICY IN THE
OPEN ECONOMY
Shocks Originating from Abroad
Net Export Effect