15-1 UNDERSTANDING FISCAL POLICY
Fiscal policy is the government’s use of taxing and spending to keep the nation’s economy stable. Decisions about fiscal policy are used to create the federal budget, a written document showing how much money the government expects to receive and spend in a year. The fiscal year for the U.S. government starts in October. The budget process begins when each federal agency estimates spending for the next year. They send these estimates to the executive branch’s Office of Management and Budget (OMB). The OMB reviews proposals and, with the President’s staff, combines all budgets into one document, which the President presents to Congress. Congress reviews the budget with help from the Congressional Budget Office. Congress then proposes its modified budget and authorizes specific spending in appropriations bills,which the President can sign or veto.
Expansionary policies are designed to increase economic output (would also decrease unemployment. When the government increases its spending it buys more goods and services, leading to economic growth. When government cuts taxes, people have more money to spend, a situation which also leads to economic growth. Policies intended to decrease output are contractionary policies (to fight inflaction. These policies allow government to decrease its spending or raise taxes, both of which will lead to slower economic growth. Fiscal policy is not easy to put into practice. Changes in the economy come slowly. During the time it takes to pass a budget and implement fiscal policy, the business cycle may change on its own.
15-2 FISCAL POLICY OPTIONS
Classical economics was a school of thought stating that markets regulate themselves and will return to equilibrium without government interference. The Great Depression challenged this view. Although prices fell, demand did not increase because so many people lacked jobs and money. John Maynard Keynes introduced a theory, called Keynesian economics (demand side), which emphasized the role of government in the economy (through government spending). Keynes said the Depression continued because neither consumers nor businesses had an incentive to increase spending. Companies would not increase production if consumers had no money to buy their products. Consumers who were unemployed had no money to spend. Keynes argued that the government could buy more goods and services, encouraging production, which in turn would put more people back to work. Fiscal policy is powerful because of the multiplier effect, the idea that every dollar change in fiscal policy creates a greater than one dollar change in the national economy. For example, if the government buys $10 billion in goods and services, GDP increases by more than $10 billion because firms spend money on wages, raw materials, and investment. Workers, suppliers, and stockholders will have money to spend. Supply-side economics states that taxes have a negative effect on economic output. Supply-siders argue that lower taxes put more money in people’s pockets, which in turn leads to greater investment and more jobs. Under President Ronald Reagan in the 1980s, the government cut taxes and implemented supply-side policies (Reagonomics).
Alex - Give me an example of how the multiplier effect would work regarding the businesses surrounding Yankee Stadium. Get me some pictures.
15 – 3 BUDGET DEFICITS AND
THE NATIONAL DEBT
When government revenues equal spending, a balanced budget exists. In reality, the federal budget is rarely balanced. A budget surplus occurs when annual revenues are higher than spending. A budget deficit occurs when spending is higher than revenues. When the government runs a deficit, it must find a way to pay for the extra expenditures. It can either create money or borrow money. Covering huge deficits with created money can lead to hyperinflation, or very high inflation.
The main way that government borrows money is by selling bonds, such as United States Savings Bonds. When government borrows money, it creates a national debt, the total amount of money the government owes to bondholders. Two problems arise from a national debt. First, it reduces funds available for businesses to borrow and invest because people buy government bonds instead of investing in business. Second, government pays interest to bondholders, and money spent paying interest cannot be spent elsewhere. In the 1980s, huge deficits led Congress to pass laws cutting federal spending. After the Supreme Court found many of these laws unconstitutional, some people suggested amending the Constitution to require a balanced budget. Opponents said an amendment would prevent government from dealing with rapid economic changes. At the beginning of the twenty-first century, budget surpluses occurred for the first time in thirty years. However, many long-term projections predict that deficits will return.