Aggregate Demand
The two fiscal policy tools
change in government spending and tax policy
Fiscal Policy is controlled by:
Congress
Classical critique of fiscal policy
- it causes inflation
- it has no effect on output in the long-run
- basically doesn't work
Federal budget (equation)
T-G
taxes- government spending
Automatic stabilizer examples
- welfare payments
- unemployment insurance
- the income tax system
Aggregate demand equation
AD= C+I+G+(X-M)
The classical growth model focuses on
the role of capital
___ economists believe in Say's Law
Classical
A deficit occurs when
tax revenues less than government spending
Automatic stabilizers (definition)
government program or policy that counteracts the business cycle without any new government action
The AD is downward sloping because
the interest rate, international, and money wealth effects
The LRAS is vertical because
potential output is unaffected by price level
Classical view of economy:
believes that the economy self corrects in the short term and returns to potential output
(focus on long run growth)
Debt (definition)
accumulation of past deficits
Functional finance (explanation)
believes governments should make spending and taxing decisions on the basis of their effect on the economy
The money wealth effect (explanation)
a fall in the price level will make the holders of money richer, so they buy more
SAS curve shift factors:
1. input prices or production costs
2. taxes or tariffs
3. imported intermediate prices
4. productivity
Keynes view of short term:
wages and prices are sticky; they don't respond quickly
Debt ceiling (explanation)
legal limit voted by congress on the total amount the federal government can borrow
Procyclical fiscal policy (definition/ explanation)
changes in government spending and taxes that increase the cyclical fluctuations in the economy instead of reducing them
International effect (explanation)
as the price level falls (assuming the exchange rate does not change) net exports will rise
An inflationary gap is short term because
resources are being used up
- employment > full employemt
- unemployment < natural rate of unemployment
- current GDP > potential GDP
A recessionary gap self corrects by:
wages and prices fall/decrease and SAS shifts down
Offsetting effect/ Crowding out (explanation)
the offsetting of the change in government expenditures by a change in private expenditures in the opposite direction
- government sells bonds to finance deficits
- they raise interest rates so people will buy them
- if it is more expensive to borrow, investment decreases
Sound finance (explanation)
believes government budget should always be balanced, except possibly in war time