Fiscal Policy

• Basics: Government, Taxing, Borrowing

Fiscal policy refers to government purchases, transfer of payments, taxes, and borrowing as they
affect macroeconomic variables such as real GDP, employment, price level, and economic growth.

Fiscal policy tools

1. Automatic stabilizers- structural features of government spending and taxation that reduce
fluctuations in disposable income, and thus consumption over the business cycle.
a. Requires no congressional action to operate.
b. Reduces drop in disposable income during recession and expansion.
2. Discretionary fiscal policy- the deliberate manipulation of government purchases, taxation
and transfer of payments to promote macroeconomic goals, such as employment, price
stability, and economic growth.

Aggregate supply

• Expansionary fiscal policy- refers to an increase in government purchases, decrease in net

taxes, or some combination of the two aimed at increasing aggregate demand enough to
reduce unemployment and return the economy to its potential output; fiscal policy used to
close contractionary gap.
• Contractionary fiscal policy- refers to a decrease in government purchases, n increase in net
taxes, or some combination of the two aimed at reducing aggregate demand enough to
return the economy to its potential output without worsening inflation; fiscal policy used to
close expansionary gap.
• The exact change of equilibrium output in the short run depends on the steepness of the
aggregate supply curve. (The steeper the short run aggregate supply curve, the less impact
the aggregate curve has to real GDP, and more impact to price level)

Assumptions in proper execution of expansionary and contractionary fiscal policy:

1. Potential output is accurately gauged.

2. The relevant spending multiplier can be predicted accurately.
3. Aggregate demand can be shifted by just the right amount.
4. Various government entities can somehow coordinate their fiscal efforts.
5. The shape of the short run aggregate supply curve is known and remains unaffected by
the fiscal policy.

Basics of Fiscal Policy

• The players: Executive & Congress

• Taxes = Revenues
• Spending = Outlays
• Issues: Slow & Political

Federal Discretionary and Mandatory Spending

• The budget can be divided into two types of spending according to how congress
appropriates the money:
o Discretionary- refers to the portion of the budget which goes through the annual
appropriations process each year
o Mandatory- required by statue
Annual Budget Process

Step 1: President submits a budget proposal.

Step 2: Congress passes a budget resolution.

Step 3: Congressional subcommittees ‘markup’ appropriation bills.

Step 4: The house and senate vote on appropriation bills and reconcile differences.

Step 5: The president signs each appropriation bill and budget is earned.

Fiscal Policies to Encourage Growth

1. Expansionary
a. Increase spending and lower taxes
- More money stimulates the economy
- Cuts taxes, increases disposable income
- Businesses expand and create jobs
Result: increased growth and higher employment
2. Contractionary
a. Increase taxes and lower spending
- Increases taxes to slow the economy and reduce inflation
- Less disposable income
- Slower business activity leads to lower profits
Result: low inflation rates and stable growth