Fiscal Policy

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Fiscal Policy
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Two types of fiscal policy

• Expansionary increased spending or decreased
  taxes
• Contractionary decreased spending or increased
  taxes

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Type of fiscal policy Changes in government spending Changes in taxes
Expansionary Increase Decrease
Contractionary Decrease Increase
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Crowding out

• Increased government spending doesnt necessarily
  lead to increased total spending
• Private spending may decrease
• Complete crowding out means no gain in total
  spending
• Crowding out could be incomplete

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John Maynard Keynes

• Too little spending high unemployment
• Previously economists thought decreased spending
  lower prices
• Keynes said this wouldnt happen because workers
  wouldnt accept lower wages
• Therefore we needed expansionary policies

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Criticisms of Keynes

• Doesnt consider crowding out
• Opened the door to government intervention into
  the economy

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Crowding in

• Decreased government spending doesnt decreased
  total spending
• Crowding in can be complete or incomplete

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Tax policies

• After-tax or disposable income income left
  after taxes are paid
• Lowering taxes increased after-tax spending
• Raising taxes decreased after-tax spending

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Supply side

• The lower the tax rate, the more people are
  willing to work
• This increases supply
• This helps the economy

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Tax cuts and tax revenues

• Will cutting taxes decrease tax revenues??
• Lower taxes might lead to increased income since
  people are willing to work more
• This will actually increase tax revenue

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Policy Condition existing Total spending affected? Policy meet objective ?
Reduce unemployment Expansionary policy No Crowding out Yes Yes
Reduce unemployment Expansionary policy Complete Crowding Out No No
Reduce unemployment Expansionary policy Incomplete crowding out Yes Yes
Reduce inflation Contractionary policy No crowding in Yes Yes
Reduce inflation Contractionary policy Complete Crowding in No No
Reduce inflation Contractionary policy Incomplete crowding in Yes Yes