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Fiscal Policy

Introduction to Fiscal Policy


Introduction; Discretionary Policy and Automatic Stabilizers

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All right now, let's move into another big topic for this course, fiscal policy. Alright. So remember we've got fiscal policy and monetary policy, monetary policy, we discussed that in other videos. Um Generally it's an entirely different chapter in the book but sometimes they put it together the monetary policy that's done by the Fed Right? The Federal Reserve, the Central Bank in the US here we're talking about fiscal policy. So what's fiscal policy? Fiscal policy involves setting the level of government spending? I'll say government spending and taxes by Well, the government. All right, so this is different than monetary policy. Okay. So don't get those two confused monetary policy is the Fed and they're dealing with the money supply and interest rates. Here, we're talking about fiscal policy with the government spending and taxes. Okay, so fiscal policy is the government and here we're focusing specifically on the spending and taxes of the federal government. Okay, so this is the national government here in the US. Um So we're gonna focus on the government spending and the taxes. So why why are these important? Well remember government spending is an important part of our GDP calculation. Right? Remember G. D. P. How did we calculated calculated consumption plus investment plus government spending plus net exports. Right. And there we go government spending, right? They're an important part of that GDP calculation. So you can imagine when we have more government spending while more government spending means more GDP. Right? Pretty straightforward. It's part of our calculation there and the higher the government spending is the higher GDP is and the opposite less government spending less GDP, so that's one of the big takeaways of this chapter. Um So it's a little straightforward there, and we'll go into more detail in other videos. Okay, So that's how government spending affects this. About taxes. Taxes also influence our GDP calculation, but in a different way, they're gonna affect the level of disposable income. So, if you guys remember disposable income, we'll go into uh well, let's go into it right now, disposable income. This is the money you have left after taxes after tax income, and you can use it. Either the money that you have as disposable income, you're either gonna use it for consumption or you're gonna save it for future consumption. Right? Either the money you have, you're either going to use it now or you're gonna use it later consumption and savings. So the more disposable income you have, well, that's what's available for household consumption. Right? So, remember, this is after taxes that we're thinking about our disposable income. So, if we have more taxes, right, what does that do that's gonna make our disposable income lower, right? Because we're paying more taxes, we have less disposable income, meaning we'll have less to spend on our consumption and the opposite troop is true if we have less taxes, right? So, if there's less taxes, well, disposable income goes up and consumption goes up, Right? So this has more of an inverse relationship, right? As taxes go up, consumption goes down. Right? Um so so they're opposites there, but you can notice consumption is also an important part of our GDP calculation. Right? So the the policy making of our government spending and our taxes is going to affect our GDP um in different ways. So now let's go into one little, one more topic here, uh that they love to talk about in fiscal policy. Let's introduce it here now. Um it's the difference between discretionary fiscal policy and automatic stabilizers. Automatic fiscal policy. Okay, so discretionary fiscal policy is a little straightforward. It's when the government takes action to change their spending or change their level of taxes, they're doing something discretionary. They're actually uh taking action being proactive in changing their spending their taxes. That's something like a tax decrease passes through Congress, right? They voted on a bill and this bill change the tax structure. So they're being proactive about what's happening. They approve $100,000,000,100 billion project to expand the highway system right there, doing something proactive to change the level of spending their taxes. But automatic stabilizers is a little different and they love to talk about automatic stabilizers because it's kind of like one of those buzzwords here in fiscal policy. Um So let's go into a little more detail about what this means, automatic stabilizers. So this is spending and taxes that change automatically through the business cycle. Okay, so this means that the government isn't doing anything proactive, They're not passing a bill in Congress, they're not changing anything they're doing, but it's going to change the level of spending or taxes automatically. So let's see how that works. We'll do one with taxes and one with spending here. So taxes is a little straightforward. Um let's think about what's happening here. So taxes during an economic boom. So remember the government isn't changing anything about their tax policy. This is changing the level of taxes just based on where we are in the business cycle. So as the economy is expanding, while the GDP inflation and income is going up, right, the economy is expanding, more people are employed, more people are making money. Um So income is increasing and as income increases, well, our taxes are going to increase as well. Right? So just what did we say above as taxes go up? How does that affect our consumption? Higher taxes means lower, disposable income and lower consumption. Right? So although people are making more money, they're paying more taxes. So this is actually going to stabilize that extra consumption that's coming in from the higher income a little bit, going to taxes and lowering consumption to it's keeping it uh under, you know, in in place a little bit. So the opposite happens during a recession. So notice there's been no policy made, there's just more money being made, more taxes being paid consumption is affected and during a recession the opposite, the economy is now contracting and we see GDP inflation and income going down, there's more unemployed people were in a recession. So people are making less money and when people are making less money, well they're paying less taxes. And the opposite is true when there's less taxes, well, disposable income goes up and consumption goes up and that's exactly what we want during a recession, during a recession, our aggregate demand is low, we're not spending as much as we want and we want to boost up spending. So this automatic stabilizer increases are spending just by being in a recession, consumption will increase because of these lower taxes being paid. Okay. Um So now the opposite side. Now, I don't want to say, we don't get confused that we're in a recession, so consumption is going to decrease, but this helps stabilize it. It's not gonna decrease as much because of this stabilization happening, right? Some consumption is going to be recovered because of this uh lower taxes being paid. Now the other side of the equation is some spending. So we'll say that this unemployment insurance is some government spending. Um So imagine this as the government paying money when people are unemployed, right? So this is more of a government transfer, but it stays the same here. Let's think of how this works. So unemployment insurance during an economic boom. So when the economy is booming, so this is more of the spending side, they're not changing any policy they have during towards unemployment insurance. But as the economy is expanding, GDP inflation and income are increasing and more people are employed, right? The economy is booming. Uh we're growing so there's more employment. So if people are employed the government doesn't make as many unemployment payments. So those unemployment payments go down and government spending goes down right? And that's exactly what we want during this economic boom. We want to keep the reins on this G. D. P. We don't want the inflation to get out of control. So we want to lower our spending a little bit and that's exactly what's happening here um during an economic boom. We see that the consumption is going down or the government spending is going down in either of these automatic stabilizers. Right? That's bringing down our G. D. P. A little bit and the opposite during a recession. So now the economy is contracting, there's less money being made and G. D. P. Is down. So they want to boost GDP a little bit and we get some of that straight out of the automatic stabilizer. Since there's less um less people employed during the recession there's more unemployment. Well there's more unemployment payments. Right? And that's going to increase our government spending. Okay so you can see how this automatic stabilizer works. There's no fiscal policy being made, no no action being taken by Congress or by the government but the level of consumption or government spending is changing, uh, just based on where we are in the business cycle. Okay, so automatic stabilizers, It's things that happen automatically that change levels of taxes and uh, spending in the, in the government. Cool. So this is some of the main things we're gonna be dealing with when we deal with fiscal policy. Let's go ahead and move on to the next video.