Fiscal Policy
Course No. PA-304
Mst. Sahiba Mahbub
Associate Professor
Department of Public Administration
Jahangirnagar University
Classical Economists
A group of the 18th and 19th centuries, including
Adam Smith known as the father of modern day
economics
What did Adam Smith and the Classical
Economists believe?
The economy was always tending toward a full
employment equilibrium and stable prices
What does laissez-faire mean?
Leave well enough alone, let the economy correct
problems itself
What happened in the Depression of 1921? Even though it was
serious the government practiced laissez-faire and the economy
recovered in a short period of time
What were policies of President Herbert Hoover in the early
1930s to combat the depression? public works projects, raised taxes,
loans to failing firms, relief programs
What were policies of President Franklin Roosevelt in 1933 to
combat the depression? public works projects and social welfare
programs, raised taxes and wages, loans to failing firms, relief programs
According to Robert Reich, an American political economist and
professor, what was the result of these government programs?
These programs helped save American capitalism
According to Thomas Woods author of Meltdown, what was the
result of these government programs? These programs prevented
the economy from seeking its equilibrium of full employment and
prolonged the depression
What is a fiscal policy?
The manipulation of government purchases, transfer payments,
taxes, and borrowing in order to positively influence the economy
How did Keynes influence fiscal policies?
He argued that fiscal policies may be necessary to bring about
full employment
How did World War II affect fiscal policies?
It showed that a government stimulus package can work
What is the Employment Act of 1946?
Its main purpose was to lay the responsibility of economic
stability of inflation and unemployment onto the federal
government
What are the four phases of the
business cycle?
• Trough, Recover, Peak, Recession
• What are the 3 pillars of Keynesian Economics?
Liquidity trap
Balanced budget multiplier
Paradox of thrift
• liquidity trap: A lack of borrowing keeps money bottled up
in savings institutions
• Keynesian solution to a liquidity trap: Government borrows
the money that consumers and business do not borrow
Balanced Budget Multiplier: When the government
taxes and spends the money there is a multiple effect
because of no savings
Paradox of Thrift: The more people save, the less
will be demand, which leads to slow growth
How does the government borrow money? It sells
bonds (securities) to the Fed or in the Open Market
What does monetizing the debt mean? The
federal government sells bonds (securities) to the Fed
and the Fed creates the money to buy the bonds
What can monetizing the debt lead to? A fall in
the value of the dollar and inflation
What is a discretionary fiscal Policy?
Government policies that require ongoing decisions by
policy makers
examples of fiscal policies? Government
purchases, Transfer payments, Taxes
Automatic stabilizers: Structural features of
government spending and taxation smooth out
fluctuations in booms and busts
examples of automatic stabilizers:
Unemployment payments, Welfare, Other government
programs
What is the point of Keynesian Economics? The
economy could be stuck at equilibrium below the
potential output for a prolonged period of time
What is an expansionary fiscal policy? An
increase in government purchases, decrease in net
taxes, or some combination of the two aimed at
increasing aggregate demand
When would the government use expansionary
fiscal policies? To stimulate the economy when
unemployment is greater than the natural rate
What is a contractionary fiscal policy? A
decrease in government purchases, increase in
net taxes, or some combination of the two
aimed at reducing aggregate demand
When would the government use
contractionary fiscal policies? To slow down
the economy when inflation is more than desired
What is the typical Keynesian policy during
recessions? To use discretionary fiscal policies
to stimulate the economy to a full employment
equilibrium
What is the multiplier? Any change in the level of spending has a
multiple effect on GDP
What is the accelerator? Any increase in spending can lead to an
increase in secondary spending, for example, a new highway may lead
to more restaurants, hotels, and gas stations
When does the accelerator have most impact on spending?
During periods of full employment
How did World War II affect fiscal policies? It showed that a
government stimulus package can work
What is MPC? The marginal propensity to consume (MPC) is a measure
of how much consumers will spend out of any addition to their income
What is MPS? The marginal propensity to save (MPS) is a measure of
how much consumers will save out of any addition to their income
If MPC is ¾, what is MPS? MPS would be ¼ because MPC +
MPS = 1
What is the value of the multiplier? 1 / MPS
If MPC is ¾, what is the value of the multiplier? 1 / ¼ = 4
How effective are fiscal policies? Automatic stabilizers are
more effective than are discretionary fiscal policies
Should we rely on automatic stabilizers? The stronger and
more effective the automatic stabilizers are, the less need
there is for discretionary fiscal policies
How effective were fiscal policies during the stagflation
of the 1970’s? Whatever we did to fight one problem we
made the other problem worse
What are lag effects? Recognition lag, Decision lag, Action lag
Do lag effects influence discretionary fiscal policies? Yes, they weaken
fiscal policies as a tool of economic stabilization
What is one’s permanent income? Income that individuals expect to receive
on average over the long term
Do consumers base their decisions on their permanent income or their
short term income? Perceived long term income
What is one thing policy makers often overlook? How fiscal policies
unintentionally affect individual incentive to work, save and invest
What is the Laffer Curve? A curve that shows that starting from zero an
increase in taxes will raise revenue but beyond a point an increase will lower
revenues
What is supply side economics? The belief that real GDP can be
increased by giving people incentives to work
What was fiscal policy in the Reagan Administration of the
1980’s? Taxes were decreased to stimulate the economy by increasing
aggregate supply
What effect does politics have on fiscal policies? There is always
the danger that politicians can use discretionary fiscal policies to suit
their short term political goals
Does the federal deficit affect fiscal policies? If we were to
increase spending by borrowing, the national debt could become
unmanageable
