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Economics - Fiscal and Monetary Policy

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Study GuideEconomics–Fiscal and Monetary Policy1. Fiscal Policy1.1What Is Fiscal Policy?Fiscal policy refers to the actions taken by thegovernmentto manage the economy. It is carried outby thelegislative and executive branchesof government.The government mainly usestwo tools:•Government spending(on things like roads, schools, and national defense)•Taxes(collected from individuals and businesses to pay for these services)By changing spending and taxes, the government can influence overall economic activity.1.2Budget DeficitAbudget deficitoccurs when:•Governmentspending is greater than tax revenuein a year.To pay for this extra spending, the government:•Borrows money•Issues long-term, interest-bearing bondsAll outstanding government borrowing over time is called thenational debt.So, when the government runs a deficit, thenational debt increases.1.3Budget SurplusAbudget surplusoccurs when:•Governmenttax revenue is greater than spending.The extra money is usually used to:•Pay off existing national debt

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Study Guide1.4Balanced BudgetAbalanced budgetoccurs when:•Governmentspending equals tax revenueIn this case, there isno deficit and no surplus.1.5Expansionary Fiscal PolicyExpansionary fiscal policy is used tostimulate the economy, especially during a recession.It involves:•Increasing government spending, and/or•Cutting taxesThis policy:•Increases the budget deficit, or•Reduces a budget surplus1.6Contractionary Fiscal PolicyContractionary fiscal policy is used toslow down the economy, usually to fight inflation.It involves:•Decreasing government spending, and/or•Raising taxesThis policy:•Reduces the budget deficit, or•Increases a budget surplus

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Study Guide1.7Classical ViewClassical economists believe that:•Markets naturally adjust on their own•Prices and wages are flexible•The economy will return to itsnatural level of real GDPwithout government interventionBecause of this, they argue that:•Fiscal policy is unnecessary•The government should run abalanced budget every year1.8Keynesian ViewKeynesian economists believe that:•Prices and wages adjustslowly, especially during recessions•Government intervention is necessary to stabilize the economyThey strongly support the use of:•Expansionary and contractionary fiscal policies1.9Combating a Recession Using Expansionary Fiscal Policy

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Study GuideFigure 1: Combating a recession using expansionary fiscal policyKeynesian ideas developed during theGreat Depression of the 1930s, when:•Unemployment exceeded 25%•Real GDP fell for many yearsKeynes argued that waiting for wages and prices to adjust would take too long. Instead, thegovernment shouldactively increase spending.1.10How Expansionary Fiscal Policy Works in a RecessionAssume the economy is in a recession:•Real GDP is atY₁, which isbelowthe natural levelY₂•Resources are unemployed•Output is too lowClassical economists say:•Unemployment will cause wages to fall•Lower wages shiftshort-run aggregate supply (SAS₁to SAS₂)•The economy returns to full employment naturallyKeynesians disagree:•Wages aresticky downward•They do not fall quickly•The recession can last a long time1.11Keynesian SolutionThe Keynesian solution is to:•Run abudget deficit•Increase government spending beyond tax revenueThis increase in spending:•Shiftsaggregate demand from AD₁to AD₂
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Document Details

University
Texas A&M University
Course
Economics
Subject
Economics

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