Fiscal Policy

The financial crisis of 2008 led to

The American Recovery Act of
2009.

The pandemic of 2020

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 Fiscal Policy

• Fiscal policy is the use of government

purchases, taxes, and transfer payments to
alter RGDP and the price level.
• Prior to 1929 the approach was laissez-faire
• The government seeks a balance between
changing tax rates and public spending.

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 The Government and Total Spending

• Aggregate demand
AD = C + I + G + (X – M)
• The effect of taxes and transfer payments
on disposable income and consumer
spending.
• Fiscal policy and the AD/AS model

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 How Does Fiscal Policy Work?
• Central banks influence money supply through
interest rates, bank reserves, gov’t securities.
• In the short-term, governments may focus on
macroeconomic stabilization.
• Response to the global crisis saw automatic stabilizers
and fiscal stimulus.
• Long run was the mortgage crisis and financial
sector
• Automatic stabilizers are features of the tax and
transfer systems that temper the economy
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 The Multiplier Effect
• The Money Multiplier explained
https://www.youtube.com/watch?v=93_Va7I7Lgg
• Ultimate increase in total purchases is greater
than the initial increase.
• Government spends $10 billion for aircraft carriers.
• Purchase adds to the total demand for goods, and
services directly.
• The purchase provides $10 billion in added income
to the aircraft carrier companies.
• Companies hire more workers, buy capital
equipment and inputs to produce the new output.
• Input owners thus receive more income because of
the increase in government purchases .
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 Marginal Propensities
• Show the proportion of extra income spent
in various areas
• Investment spending by firms
• Savings by households
• Spending on imports
• If 80% spent on U.S. products, marginal
propensity to consume will be:
80/100 = .8

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 Multiplier Process
• Uses marginal propensity to consume
1/1-MPC
• If consumers spend .8 and save .2 0f every $1
of extra income, the multiplier is:
1/1-0.8 =1/0.2 =5
• Thus every $1 of new income generates $5 of
extra income
• Extra income of $10,000 generates $50,000
of extra income. How?

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 Multiplier effect on Local Independent
Businesses
• Components or the multiplier effect in local
businesses
• Direct impact: spending in the local economy
• Indirect impact: business spends at other area
businesses
• Induced impact: additional consumer spending
as a result of the direct and indirect impact

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 The Multiplier And The Aggregate
Demand Curve
• Buying additional products affects AD by
increasing the incomes of input owners -
this is the initial effect.
• The secondary effect ― the greater income
that results ― will lead to increased
consumer purchases.

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 Tax Cuts and the Multiplier

• If the government wants to use fiscal

stimulus, increased government spending is
one alternative.
• The other is to stimulate business and
consumer spending through tax cuts.

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 Taxes and Investment Spending

• Taxes can also stimulate investment

spending.
• Cutting corporate-profit taxes could fuel
additional investment spending.
• Tax cuts designed for consumers and
investors can stimulate aggregate demand.

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 M1 and M2
• M1
• physical currency and coin
• demand deposits
• travelers checks
• other checkable deposits and negotiable order of
withdrawal (NOW) accounts.
• M2:
• includes all elements of M1 as well as "near money."
• Near money refers to savings deposits, money
market securities, mutual funds and other time deposits.
 

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