FISCAL POLICY

Inflation

RealGDP

AS1

AD1 AD2

Economy in recession, Unemployment = 9.1%

Expansionary Fiscal Policy needed

Lower Taxes & ↑ Gov’t spending

C ↑ & G ↑ => AD shifts right

End result: higher GDP, moreJobs & slightly higher inflation

Macroeconomic Theories

Classical, Keynesian & Supply Side Economics

Inflation

RealGDP

AS1AS1

AD1

Economists often Disagree• Are tax cuts good or bad?

• Do Large Deficits always raise interest rates?

• Will taxing “rich” people significantly lower GDP?

IT DEPENDS!

The answer to most economic questions is:

2013 U.S. Economy

Economy well below full potentialWhat Now?

Tax Cuts?Gov’t Spending?New Incentives?Self-Regulation?

AD1

Inflation

RealGDP

AS1

Protests In France & Greece Turn Violent

Europe & AusterityAusterity = Extreme Gov’t budget cuts & tax increases

Often AFTER crowding out!

Classical vs. Keynesian Reading

CLASSICAL Economists

– Markets are naturally self regulating

– No government intervention necessary

– Recessions are temporary

– Great Depression challenged Classical View

Classical economists were the 1st school of economic thought starting in 1776Adam Smith was the founder and they believed:

John Keynes 1883-1946

• Founder of Keynsian Economics– Greatly influenced Fiscal Policy after the Great Depression

• Believed recessions could be permanent

• Argued investment by Government can moderate the “ups & downs” of business cycle

Theory – Period Challenged

Classical Theory - Great Depression (1929)

Keynesian Economics- Stagflation (late 1970’s)

Neo-Classical Theory Great Recession (2008)

Keynes-Stimulus Debates

• Economists argue over the benefits/costs of both expansionary Fiscal Policy

Benefits Costs/Risks Inflation

RealGDP

AS1AS1

AD1

Austrian Economics

• Friedrich Hayek (1899 – 1992)– Austrian School of Economics

• Against active Fed Policy• Promoted “self regulation” of free market

• Believed low interest rates led to Malinvestment

Jobless Recovery

• http://marketplace.publicradio.org/display/web/2010/06/18/mm-a-jobless-recovery-and-a-lost-generation/

Supply-Side Policy

• Basic Belief: Government Incentives Matter

• Goal: use incentives to encourage new business!– shift the aggregate supply curve right

– when PPF shifts right => AS shifts right

• The supply-side toolbox consists of:– Tax cuts to stimulate work, saving, and investment (I↑)

– Deregulation to reduce production cost/stimulate investment.

– Expenditures on education training/research expands capacity to produce

PriceLevel

Real GDP

AS

AD

Cars

TechnologyGoods

. B

100

100

----------

----

----

---50

50

United States

GDP GDP GDP

What creates Economic Growth?

INCENTIVES MATTER!!!

Classical, Keyensian and Supply Side Economists approach the same economic problems in different ways!

AD1

Inflation

RealGDP

AS1

Growing GDP in the Long Run

Qty

Food

Qty

Shelter

. B

. A

. C

(100, 0)

(0,100)

(50,50)

(100, 0)

(0,100)

(50,50)

U.S.PPF Graph

Innovation