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Chapter 27: Problem 1

If Congress and the president decide that an expansionary fiscal policy is necessary, what changes should they make in government spending or taxes? What changes should they make if they decide that a contractionary fiscal policy is necessary?

Short Answer

Expert verified
For an expansionary fiscal policy, either increase government spending or decrease taxes, or do both. For a contractionary fiscal policy, either decrease government spending or increase taxes, or implement both changes.

Step by step solution

01

Understanding Fiscal Policy

Fiscal Policy refers to government actions related to spending and taxing. An expansionary fiscal policy involves either an increase in government spending or a decrease in taxes, or both. This policy is applied when the government seeks to stimulate the economy during a recession. Contrarily, a contractionary fiscal policy means decreasing government spending or increasing taxes, or both. This policy is applied when the economy is overheating, i.e., inflation is high.
02

Changes for Expansionary Fiscal Policy

If the government and president decide that an expansionary fiscal policy is necessary, this indicates a need to stimulate the economy. Suggested changes could include increasing government spending on public works, investment in infrastructure or other projects that can generate jobs and decrease unemployment. Alternatively or additionally, they could decrease taxes, giving consumers more spending power, which in turn would stimulate demand, pushing businesses to increase production.
03

Changes for Contractionary Fiscal Policy

If it's decided that a contractionary fiscal policy is necessary, this suggests that the economy might be overheating and needs to slow down to decrease inflation. The changes to be made include decreasing government spending, which can slow economic activity. This could involve reducing expenditure on public projects. Alternatively or additionally, taxes may be increased. This would decrease consumers' disposable income, reducing their spending power, hence slowing the economy.

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Most popular questions from this chapter

What are the key differences between how we illustrate an expansionary fiscal policy in the basic aggregate demand and aggregate supply model and in the dynamic aggregate demand and aggregate supply model?

(Related to Solved Problem 27.6 on page 971 ) A 2015 article in the Wall Street Journal noted that an official of the European Union was forecasting that "Greece faces two years of recession amid sharp budget cuts." What typically happens to a government's budget deficit during a recession? Do governments typically respond with budget cuts as the Greek government did? Briefly explain.

(Related to the Apply the Concept on page 969) The following is from a message by President Herbert Hoover to Congress, dated May 5,1932: I need not recount that the revenues of the Government as estimated for the next fiscal year show a decrease of about \(\$ 1,700,000,000\) below the fiscal year \(1929,\) and inexorably require a broader basis of taxation and a drastic reduction of expenditures in order to balance the Budget. Nothing is more necessary at this time than balancing the Budget. Do you think President Hoover was correct in saying that, in \(1932,\) nothing was more necessary than balancing the federal government's budget? Briefly explain.

Wall Street Journal writers Josh Zumbrun and Nick Timiraos published answers to several of their readers' questions regarding the federal government's debt. The following were two of the questions. Write a brief response to each question. a. Why is government debt different from mine? b. How important is it to pay off this debt?

Why can a \(\$ 1\) increase in government purchases lead to more than a \(\$ 1\) increase in income and spending?
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