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chapter twelve
fiscal policy

CHAPTER OVERVIEW

This chapter looks briefly at the legislative mandates given to government to pursue stabilization of the economy; it then explores the tools of government stabilization policy in terms of the aggregate demand-aggregate (AD-AS) model. Next, some fiscal policy measures that automatically adjust government expenditures and tax revenues when the economy moves through the business cycle phases are examined. Finally, problems, criticism, and complications of government’s fiscal policy are addressed.

WHAT’S NEW

The full-employment budget discussion has been revised and clarified in a section entitled “Evaluating Fiscal Policy.” Current real-world budget surpluses eliminated the need to emphasize the structural deficit. Also the section on budget’s expansionary bias has been deleted. Tables and graphs have been updated and revised for clarity. End-of-chapter questions 7 and 9 and Internet questions are new.

INSTRUCTIONAL OBJECTIVES

After completing this chapter, students should be able to:

1. Identify the Employment Act of 1946 and the roles of the CEA and JEC.

2. Distinguish between discretionary and nondiscretionary fiscal policy.

3. Differentiate between expansionary and contractionary fiscal policy.

4. Recognize the conditions for recommending an expansionary or contractionary fiscal policy.

5. Explain expansionary fiscal policy and its effects on the economy and Federal budget.

6. Explain contractionary fiscal policy and its effects on the economy and Federal budget.

7. Describe the two ways to finance a government budget deficit and how each affects the economy.

8. Describe the two ways to handle a government budget surplus and how each affects the economy.

9. Give two examples of how built-in stabilizers help eliminate recession or inflation.

10. Explain the differential impacts of progressive, proportional, and regressive taxes in terms of stabilization policy.

11. Explain the significance of the “full-employment budget” concept.

12. List three timing problems encountered with fiscal policy.

13. State political problems that limit effective fiscal policy.

14. Explain and recognize graphically how crowding out and inflation can reduce the effectiveness of fiscal policy.

15. Give two examples of complications that may arise when fiscal policy interacts with international trade.

16. Give an example of supply-side fiscal policy and three possible positive effects from it.

17. Define and identify terms and concepts at the end of the chapter.

COMMENTS AND TEACHING SUGGESTIONS

1. Fiscal policy, especially tax policy, is one of the subjects that students usually find very interesting. The chapter provides an excellent opportunity to establish the ties between theory and real-world applications.

2. To give a more human dimension to this chapter, students may identify current members of the Council of Economic Advisers (end-of-chapter question #1). You could assign excerpts from the latest Economic Report of the President, which the Council helps to prepare.

3. Current federal tax or spending issues can illustrate the timing, administrative, and political problems with discretionary fiscal policy. The 2001 tax cut proposal illustrated many of these issues.

4. Current data on the federal budget can be obtained from the Federal Reserve Bulletin, Economic Indicators, the Survey of Current Business, or the Economic Report of the President or websiste given in web-based question #18.

5. Remind students of the multiplier impact that results from changes in government spending and/or taxes. Most students can understand these concepts without reference to the numerical examples. Numbers often confuse those with “math anxiety,” and if you skipped Chapters 9 and 10, they will benefit from a brief overview of the concept.

6. The Last Word for the...
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