Unit 6: Fiscal Policy and the Relationship Between Inflation and Unemployment
Governments use various policies and tools to steer the macroeconomy toward three main goals: full employment, price stability, and economic growth. In this unit, we study fiscal policy, which involves taxing and spending policies, including the fiscal legislation Congress enacts in the United States.
Completing this unit should take you approximately 10 hours.
Upon successful completion of this unit, you will be able to:
- identify the major components of the U.S. government revenues and spending;
- define budget surplus, budget deficit, and balanced budget, and determine how they are related to the national debt;
- identify the goals and tools of discretionary fiscal policy and distinguish them from automatic stabilizers;
- identify the lags in carrying out discretionary fiscal policy;
- analyze the way government borrowing causes crowding out of private investment;
- use the Phillips curve to identify the relationship between inflation and unemployment;
- use the model of aggregate demand and aggregate supply to explain a Phillips phase, a stagflation phase, and a recovery phase;
- use the equation of exchange to relate money supply growth and inflation in the long run;
- relate labor market dynamics to the achievement of equilibrium in the short run and long run;
- compare and contrast fiscal policy and monetary policy; and
- examine attitudes of the Classical, Keynesian, and Monetarist schools of economic thought on policies to stabilize the economy.
6.1: Fiscal Policy
Read this chapter to learn about how the government's fiscal actions influence aggregate demand. The chapter first introduces the components of the government's budget and then discusses discretionary fiscal policy and automatic stabilizers used to influence
the economy. Some lags in the implementation of fiscal policy are identified and the concept of crowding out is introduced. Attempt the "Try It" exercises at the end of the section.
Read this chapter, which identifies fiscal policies governments use to combat inflation and recession. John Petroff provides information about government taxing and spending and prepares you to continue studying the role governments play in the macroeconomy.
The government spending increase section explains how policy makers use the government spending multiplier to calculate how to manipulate the economy to mitigate inflation or recession, beyond the ordinary uses of taxes. The multiplier calculates how much governments should increase or decrease spending to foster economic stability.
The tax increase section explains how policy makers use the tax multiplier to calculate how to manipulate the economy to mitigate inflation or recession, beyond the ordinary uses of taxes. The tax multiplier calculates how much governments should increase or decrease taxes to foster economic stability.
The balanced budget multiplier section explains how policy makers use the balanced budget multiplier to calculate how to reduce the budget deficit by collecting more taxes. This allows governments to match their revenue and expenses to create a balanced budget.
The following three videos walk you through the components of the government's budget - taxation (revenue) and government spending, and the way in which they are used as tools of discretionary fiscal policy. The issue of crowding out is shown to result from excessive government borrowing.
Watch this lecture, which discusses the tax lever of fiscal policy or how government can impact aggregate demand through the use taxation while keeping government spending unchanged.
6.2: Inflation and Unemployment
Read this chapter to examine the relationship between inflation and unemployment. As you will see, while there have been some periods in which a trade-off exists between inflation and unemployment, there are also periods in which such clear-cut negative relationship between these variables falls apart. The chapter offers some explanations for these variable behaviors and the stabilization policies that are used to address undesirable trends in the variables.
The Phillips curve shows a trade-off between a high rate of inflation and a high rate of unemployment during certain periods of time in our history. Read this chapter to learn about this trade-off.
Economist economist Bill Phillips described an inverse relationship between unemployment and inflation visible in the data in 1958. This relationship was later named the "Phillips Curve". Learn about the macroeconomic debates that this concept stirred over time.
Monetary policy and fiscal policy pursue similar goals - the achievement of high employment and stable price. The two types of economic policy, however, differ in their tools, implementation, and the primary entity making policy decisions. This video compares and contrasts fiscal policy and monetary policy.
Review sections 7.2 and 7.3 of Chapter 7 in order to examine the relationship between the labor market dynamics and the achievement of equlibrium in the short run and the long run. Note the role of wage and price stickiness.
6.3: History of Economic Policy and the National Debt
Read this chapter to examine macroeconomic attitudes towards economic policies of the three main schools of economic thought: Classical, Keynesian, and Monetarist. Also, learn about modern day interpretations of the main ideas.
Read this article for additional perspective about macroeconomic goals and the inherent conflict among them as they relate to a global environmental context.
Read this chapter by Christopher Conte, a former editor and reporter for the Wall Street Journal, and Albert R. Karr, a former Wall Street Journal reporter, for a historical perspective on fiscal and monetary policy, its evolution over the years, and its current functionality.
Read this article for more information about these competing perspectives. This section contains four subsections: "Wages and Spending," "Excessive Saving and Interest Rates," "Active Fiscal Policy," and "Multiplier Effect". Focus your attention on the portions within the four subsections that emphasize the short-run. You may observe that the differences among the various subsections tend to deal with the underlying nature of change.
Read each of the four webpages linked from this section: "Arguments For and Against Discretionary Monetary Policy," "Arguments For and Against Fighting Recession with Expansionary Monetary Policy," "Arguments For and Against Fighting Recession with Expansionary Fiscal Policy," and "Arguments For and Against Inflation Targeting Policy Interventions". You will gain additional insights about policy formation, implementation, and evaluation. In each case, consider whether the right questions were asked and whether the proper measures received focus. Which side of each of these debates would you find yourself?
Unit 6 Discussion and Assessment
After reviewing the unit materials, please post and respond to the following topics on the course discussion board. Feel free to start your own related posts and respond to other students' postings as well.
How does a budget deficit differ from the
national debt? What are the types of lags encountered when using fiscal policy? Which of the types do you think is the most realistic? Explain your reasoning. Explain some consequences of pursuing a balanced budget during a severe economic contraction
and its implication for the size of a multiplier of your choice.