Fiscal Policy and Stimulus Flashcards
What’s a RECESSIONARY GAP?
- When an economy’s output is BELOW its potential
- What It Looks Like: workers are unemployed, factories are sitting unused :(
What’s an INFLATIONARY GAP?
- When an economy’s output briefly rises ABOVE its potential
- What It Looks Like: unemployment is super low, and factories are working overtime…but it’s not sustainable :(
True or false? Every modern industrialized economy has seen times of boom and bust.
True!
True or false? High unemployment and inflation rates can cause social upheaval.
True!
- High unemployment can mean higher depression/suicide, violence, and social upheaval…
- High inflation can wipe out peoples’ savings, leading them to protest and riot in anger
Is there a way to help control inflation and unemployment to avoid it getting out of hand?
Maybe. Some people think the government needs to step in and help balance things when the economy gets out of hand.
What’s FISCAL POLICY?
It’s the government stepping in when the economy is running too fast or too slow (kind of like a car driver hitting the gas pedal or brakes).
What are the two main ways the government uses fiscal policy to regulate the economy?
- Changing government spending (more or less)
2. Changing taxes (more or less)
How does EXPANSIONARY FISCAL POLICY work?
- The government either cuts taxes or increases its spending (–usually some of both) to free up more money into the economy
- This is when the economy is too slow
How does CONTRACTIONARY FISCAL POLICY work?
- The government either raises taxes or decreases its spending (–usually some of both) to slow down the money supply in the economy
- This is when the economy is too fast
Which is rarer: contractionary or expansionary fiscal policy? Why??
- Contractionary!
- Because politicians know they won’t be popular if they become known for slowing down the money and job supply! Even if it’s good for the economy…people will hate them.
So…does fiscal policy actually work?
It’s divided in a heated debate…
- Traditional (“Classical”) economists have long believed you just have to let the economy fix itself, and that interfering will just put the government into debt and cause problems.
- Followers of Keynes (“Keynesians”) believe the government CAN and SHOULD help, even if in the long run the economy would have fixed itself. Their reasoning: “In the long run, we’re all dead.”
What’s CROWDING OUT?
When government spending competes with (“crowds out”) private spending, and therefore hurts the economy.
What’s the difference between how Classical and Keynesian economists understand Crowding Out?
- Classical economists believe that fiscal policy ALWAYS causes this problem (and that’s why they are against it)
- Keynesians believe that fiscal policy ONLY causes this problem if everyone in the economy is spending and producing everything they can…
- BUT, in a recession, this is not happening. So Keynesians don’t think government spending is competing at all – it’s actually helping boost private spending.
What is AUSTERITY?
- When the government RAISES taxes and CUTS government spending during a recession to reduce debt
What was the difference between America’s and Europe’s responses to the global recession in 2009?
- America INCREASED government spending and CUT taxes to try to help the economy
- Europe used Austerity: they CUT government spending and RAISED taxes to try to reduce debt
- In the long run, America’s economy has gotten stronger, and Europe’s has gotten weaker.
