Managing Aggregate Demand: Fiscal Policy

Gov’t has played passive role; both G & T fixed

Looking at how gov’t uses spending and taxes to effect demand-side of economy

FIXED TAXES: taxes that don’t vary with GDP (property taxes)

VARIABLE TAXES: taxes that do vary with GDP (income taxes)

*Certain types of tax cuts are expected to increase ASCan be used to reward working, saving, and

investing moreResponse to tax cuts-increase in availability in

labor and capital

ASoAS1

ADo

PL

RGDPEGDPo EGDP1

PLeo

PLe1

*Fights inflation and unemployment simultaneously

1. Lower personal income taxes1. People more willing to work since gov’t isn’t

taking as much of their additional wages2. Productivity up, costs down, profit up, AS up

2. Reduce taxes on income from savings1. People will save more, make more money

available for loans, businesses can borrow to buy more tech. advanced capital

2. Production up, costs down, profit up, AS up

3. Reduce capital gains tax1. Reduces taxes on income from sale of assets2. Gives incentive to invest

1. Reduce corporate income taxes1. Increases amount profit companies keep

and can reinvest in capital

2. Pending tax credits for research and development

1. Incentive to increase use of technology

ADo

ASo

AD1

EGDP1EGDPo

PLeo

PLe1 *Successful supply-side tax cut

1. Effectiveness of supply-side policy depends on which types of taxes are cut

2. Supply-side tax cuts have their primary impact on AD rather than AS in the short run

3. Supply-side tax cuts are likely to widen income inequalities

4. Supply-side tax cuts are almost certain to lead to bigger budget deficits

5. Supply-side tax cuts should be seen as a way to promote long-term ec. growth

Multipliers used to determine the appropriate fiscal policy

PLANNING FISCAL POLICY IS LIKE SHOOTING THROUGH A DENSE FOG AT A ERRATICALLY MOVING TARGET WITH AN INACCURATE GUN AND SLOW-MOVING BULLETS

Expansionary FP: cut taxes, increase transfers, increase G

Contractionary FP: increase taxes, decrease transfers, decrease G

Liberals: US’s needs include better schools, healthcare, diminishing poverty, environment, infrastructure, etc.For EFP: increase G. For CFP: increase taxes

Conservatives: Gov’t limits daily lives and circumscribes our freedomFor EFP: cut taxes. For CFP: decrease G