Introduction to Fiscal Policy

Summary

This video explains how fiscal policy, including expansionary and contractionary approaches, is used to manage economic fluctuations. During a recession, expansionary fiscal policy—such as increased government spending—can stimulate GDP growth by creating jobs and triggering a ripple effect throughout the economy. In contrast, when the economy is at full employment, increased spending may crowd out private investment. Contractionary fiscal policy involves saving during economic booms by raising taxes or cutting spending. The video also touches on political challenges in maintaining surpluses and controlling deficit spending.

Takeaways

• 🎯 Expansionary fiscal policy involves cutting taxes and increasing government spending to stimulate the economy.
• 📉 Fiscal policy is used to manage fluctuations in the business cycle, mitigating booms and busts.
• 🏗️ If an economy is at full employment, additional government spending could crowd out private spending, as resources are fully utilized.
• 🚧 In a recession, with underused labor and capital, government spending can boost GDP by increasing demand for idle resources.
• 💸 A dollar spent by the government during a recession may have a ripple effect, increasing GDP by more than the initial amount spent.
• 🌊 This ripple effect, where increased spending leads to further economic activity, is called the 'fiscal multiplier.'
• 🔄 Contractionary fiscal policy is the opposite of expansionary, involving saving during economic booms by raising taxes or cutting spending.
• 📈 Expansionary policy works best during recessions, where there is excess capacity in the economy.
• 💼 Fiscal policy involves managing taxes, spending, and borrowing to influence economic activity.
• 📊 There are challenges in maintaining government surpluses, and we'll explore the political difficulties of continual deficit spending.

Q & A

What is fiscal policy?

Fiscal policy refers to the government's policies on taxes, spending, and borrowing, used to mitigate fluctuations in the business cycle and even out booms and busts.

What is expansionary fiscal policy?

Expansionary fiscal policy is when the government cuts taxes or increases spending in order to stimulate the economy, particularly during periods of economic downturn.

Why doesn't expansionary fiscal policy increase GDP during full employment?

During full employment, resources like labor and capital are already fully utilized. If the government increases spending, it takes these resources away from the private sector, resulting in crowding out private investment rather than increasing GDP.

How does expansionary fiscal policy work during a recession?

During a recession, resources are underused, with unemployed labor and idle capital. Government spending can hire these unemployed resources, leading to an increase in GDP. This increased spending can have a multiplier effect throughout the economy.

What is the fiscal multiplier?

The fiscal multiplier is the ripple effect of increased government spending, where the initial spending leads to more spending in the economy as people use their income to purchase goods and services, which in turn causes further economic activity.

Can government spending during a recession increase GDP by more than the initial amount spent?

Yes, due to the fiscal multiplier effect. For example, if the government hires unemployed workers, those workers spend their new income, creating more demand in other sectors, which can further increase GDP.

What is contractionary fiscal policy?

Contractionary fiscal policy occurs when the government saves during an economic boom by either increasing taxes or decreasing spending. This is done to prevent overheating of the economy.

What are the challenges of achieving government surpluses?

Political economy issues, such as continual deficit spending and difficulty in reducing government spending during booms, make it challenging for governments to achieve and maintain surpluses.

Why might government spending crowd out private investment during full employment?

At full employment, the economy is already using its resources efficiently. Additional government spending would redirect resources (like labor and capital) away from private investment, rather than increasing overall production.

Why is it important for the government to save during economic booms?

Saving during booms helps prevent inflation and overheating in the economy. It also provides a financial cushion that can be used during economic downturns to stimulate the economy through expansionary fiscal policy.