Government and 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.
2. The Use of Fiscal Policy to Stabilize the Economy
- Discretionary fiscal policy may be either expansionary or contractionary.
- A change in government purchases shifts the aggregate demand curve at a given price level by an amount equal to the initial change in government purchases times the multiplier. The change in real GDP, however, will be reduced by the fact that the price level will change.
- A change in income taxes or government transfer payments shifts the aggregate demand curve by a multiple of the initial change in consumption (which is less than the change in personal disposable income) that the change in income taxes or transfer payments causes. Then, the change in real GDP will be reduced by the fact that the price level will change.
- A change in government purchases has a larger impact on the aggregate demand curve than does an equal change in income taxes or transfers.
- Changes in business tax rates, including an investment tax credit, can be used to influence the level of investment and thus the level of aggregate demand.