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.

3. Issues in Fiscal Policy

LEARNING OBJECTIVES

  1. Explain how the various kinds of lags influence the effectiveness of discretionary fiscal policy.
  2. Explain and illustrate graphically how crowding out (and its reverse) influences the impact of expansionary or contractionary fiscal policy.
  3. Discuss the controversy concerning which types of fiscal policies to use, including the arguments from supply-side economics.

The discussion in the previous section about the use of fiscal policy to close gaps suggests that economies can be easily stabilized by government actions to shift the aggregate demand curve. However, as we discovered with monetary policy in the previous chapter, government attempts at stabilization are fraught with difficulties.