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![Page 1: Understanding Fiscal Policy. Revenues - Expenses Federal Budget is a written document indicating the amount of money the government expects to receive.](https://reader035.fdocuments.us/reader035/viewer/2022062322/56649ed05503460f94bde8c2/html5/thumbnails/1.jpg)
Understanding Fiscal Policy
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Revenues - Expenses
• Federal Budget is a written document indicating the amount of money the government expects to receive for a certain year and authorizing the amount the government can spend that year.
• Fiscal Year – a twelve-month period that can begin on any date
• The federal budget takes about 18 months to prepare
• Budgets are tools used by consumers and the government to better manage their resources
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Government Spending DecisionsForces Affecting Government Spending Decisions
Economic Forces
• Changes in the economy, including changes in growth rates, interest rates, employment rates, income distribution, and other indicators
• Differing opinions about how changes in taxation would affect the economy
Political Forces• Desire of members of Congress to please constituents
• Different views of the political parties
Cultural Forces• American belief in limited government
• American belief in economic freedom
Psychological Forces
• Individual beliefs about the role of government
• Individual attitudes toward paying taxes
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Budget Terms
• Balanced Budget = revenues are the same as expenditures
• Budget Surplus = annual revenues are higher than spending
• Budget Deficit = government expenditures exceed government revenues
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Deficit
• Must find a way to pay for the extra expenditures
• Two possible solutions– Create money
• Can lead to inflation or hyperinflation
– Borrow money• Treasury bill, notes and bonds• Other countries own our national debt
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Treasury Securities
• Treasury bill – a government bond that is repaid within three
months to one year
• Treasury note – a government bond that is repaid within two to
ten years
• Treasury bond – a government bond that can be issued for as
long as 30 years
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National Debt• The sum of all the yearly deficits• As of April 8, 2009 the national debt clock
was $11.156 trillion• The estimated population of the United
States is 305,964,539• So, each citizen's share of this debt is
$36,462.67 • The National Debt has continued to
increase an average of $3.85 billion per day since September 28, 2007!
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U.S. Federal Debt
• April 6, 2009 $11,149,346,771,082.81
• JAN 21, 2005 $7,614,468,360,651.30
• JAN 19 2001 $5,727,776,738,304.64
• JAN 21,1997 $5,310,267,076,516.85
• Jan 20 1993 $4,188,092,107,183.60
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Factoids about the Debt• GDP = 13.13 trillion – do you see a
problem if we produce less than our debt?• Daily increase of debt = $1.52 billion • Hourly increase of debt = $75 million• Second increase of debt = $13,000• Interest on the debt is the third single
largest budget item (Social Security and defense)
• Paying interest means we cannot spend money elsewhere in the U.S.
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What can be done?
• Balance the Budget
• Increase Taxes
• Decrease Spending
• No Pork Barreling
• Term Limits on Congress
• Reduce Foreign Aid, Grants, Etc.
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Stabilization of Economy
• The government’s economic priorities are seen by analyzing the budget.
• Also can be seen by the way they use Fiscal Policy
• Fiscal means “basket” or “bag” , or “pool of money” (Latin, not Greek)
• Specifically, money held by the government
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Definition• Fiscal policy is a
way of managing the nation’s financial affairs through a program of expenditures and taxation.
• Purpose is to achieve particular economic goals
• Stabilization
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Two Types of Fiscal Policy
1. Expansionary Fiscal Policy• Increase Government spending and/or• Decrease Government taxes
– Objective of this type of policy is to increase total spending in the economy to reduce the unemployment rate.
– Encourage growth in the economy• Multiplier Effect – the idea that every
one dollar of government spending creates more than one dollar in economic activity
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Unemployment – Increase Spending
• If the unemployment rate is high it is a result of people not spending enough money in the economy.
• If people spend more money, firms will sell more goods, and they will have to hire people to produce more goods.
• Government chooses to spend more on health care, education, national defense, or any other program, that results in firms selling more goods.
• When firms sell more goods, they hire more workers to produce additional goods and unemployment goes down.
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Unemployment – Decrease Taxes
• Consumers have after tax income to purchase all their needs and wants
• If the government lowers the taxes, consumers have more income to spend.
• The total spending in the economy rises as a result of a tax cut.
• Increased spending means firms sell more goods, and firms hire additional workers.
• Unemployment rate goes down as a result of more people working.
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2. Contractionary Fiscal Policy• Decrease Government spending and/or• Increase Government taxes
– Objective is to reduce total spending in the economy in order to reduce inflation
– Cool the economy down
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Inflation – Decrease Spending
• Remember – Inflation is demand growing faster than the supply – “too much money chasing too few goods”
• Decrease in government spending is a decrease in overall spending in the economy, so firms sell less goods.
• When they sell less, they end up with a surplus and a decrease in the prices.
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Inflation – Increase Taxes
• Economists believe the opposite will happen if taxes are raised
• After tax income will be lower, so people will buy less, lowering total spending in the economy.
• Firms keep less profit so they decrease buying land, labor and capital, cut production and lowers the GDP
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Limits of Fiscal Policy
• Clumsy and difficult to put into practice.
• Hard to know real status of the economy.
• Lag time can be up to 18 months
• Political pressure from constituents
• Hard for branches to work together
• Temporary fix, could slide into recession
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Classical Economists
• Looked at supply and demand of individual products, not the aggregate (whole) economy
• Believed it would move to equilibrium on its own, no government interference
• Adam Smith
• David Ricardo
• Thomas Malthus
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Keynesian Economists
• Looked at the economy as a whole
• Looked at productive capacity (maximum output that an economy can produce without big increases in inflation)
• John Maynard Keynes– “In the long run we are all dead.”– Could not wait for the economy to recover on
its own, challenged Classical view
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Terms to Know
• Demand-side economics - idea that government spending and tax cuts help an economy by raising demand
• Keynesian economics - a form of demand-side economics that encourages government action to increase or decrease demand and output
• Supply-side economics – a school of economics that believes tax cuts can help an economy by raising supply (Reaganomics)
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Fiscal Policy History• Hoover and previous – Classical• FDR – Keynesian – war spending• 1945 – 1960 – let the good times role• Kennedy – 6.7% unemployment – cut income
taxes from 90% to 35% • Vietnam War increased spending and had the
look of Keynesian success• Late 1970’s – unemployment and inflation• 1981 – Reaganomics – cut taxes by 15% over
three years – huge deficits because of spending
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How successful do you think Fiscal Policy Is?