5/5 Fiscal Policy Options

Fiscal Policy Options

★Classical Economics

●Free markets regulate themselves
●Largely discounted by the Great

Depression

★Keynesian Economics

●British economist John Maynard

Keynes (1930s)

●A broader view

■Keynes focused on the economy

as a whole

Multiple Choice

A form of demand-side economics that encourages government action to increase or decrease demand and output.

• Supply-side economics

• Monetarism

• Fiscal policy

• Keynesian economics

●A new role for government

■government can stimulate the

economy by spending or tax cuts

■even deficit spending
■called demand-side economics
■increased disposable income = an

expanding economy

Multiple Choice

Keynesian economists believe that the primary factor driving economic activity and short-term fluctuations is the demand for goods and services. The theory is sometimes called ______

• Demand-Side economics

• Supply-Side economics

• Recession

• Fiscal economics

●Avoiding recessions and depression

■a country can “spend” its way out of

recession

■spending by:

○government, businesses, and

consumers

○adds money to the total economy

●Controlling inflation

■government can use

contractionary fiscal policy to slow
the economy down

●The multiplier effect

■every dollar spent creates a

greater than one dollar change in
the economy

Multiple Choice

What is the multiplier effect?

• The effect of one action having a lower impact than the initial action

• Every dollar spent creates a greater than one dollar change in the economy

• The Government cuting deficit spending creates more debt

• Every dollar spent decreases the chance someone will pay the costs

●Automatic Stabilizers

■automatically triggers benefits as

needed

○unemployment insurance
○federal entitlement programs
○progressive income tax

★Supply-Side Economics

●Stresses the influence of taxes on the

economy

■supply-siders believe that taxation

has a strong negative influence on
the economy (and therefore
supply)

Multiple Choice

A form of economics focusing on tax cuts to help the economy by raising supply.

• Supply-side economics

• Fiscal policy

• Keynesian economics

• Monetarism

●The Laffer curve

■the relationship between tax rates

and government revenue

■higher rates can cause tax

revenue to actually fall

●Taxes and Output

■the heart of supply-side theory
■tax cuts can raise government

revenue by increasing jobs

■called “voodoo” economics in the

1980s

○Assumption if you cut taxes

people will spend more

Multiple Choice

This economic model encourages lowering taxes on the wealthy and discourages the use of monetary policies to affect the economy.

• Keynesian

• Supply-Side

• Monetarist

• Demand-Side

★Fiscal Policy in American History

●Great Depression

■Keynesian economics

●World War II

■government spending went up

dramatically

■verified Keynesian theory by

ending the Great Depression

●The Kennedy administration

■tax cuts stimulated the economy

●1980s

■supply-side economics was

dominant

■massive tax shortfalls and

increased government spending
led to large yearly deficits