3.8 Fiscal Policy

a. Define fiscal policy and related terms. b. Explain (using graphs as appropriate) the short-run effects of a fiscal policy action. c. Calculate the short-run effects of a fiscal policy action.

• Governments implement fiscal policies to achieve macroeconomic goals, such as full employment.
• The tools of fiscal policy are government spending and taxes/transfers.
• Changes in government spending affect aggregate demand directly, and changes in taxes/transfers affect aggregate demand indirectly.
• The government spending multiplier is greater than the tax multiplier.
• Expansionary or contractionary fiscal policies are used to restore full employment when the economy is in a negative (i.e., recessionary) or positive (i.e., inflationary) output gap.
• Fiscal policy can influence aggregate demand, real output, and the price level. [See also EK MKT-5.E.2 for the effect on exchange rates.]
• The AD–AS model is used to demonstrate the short-run effects of fiscal policy.
• Enduring understanding POL-1: Fiscal and monetary policy have short-run effects on macroeconomic outcomes.

Define why there are lags to discretionary fiscal policy.

• In reality, there are lags to discretionary fiscal policy because of factors such as the time it takes to decide on and implement a policy action.
• Enduring understanding POL-1: Fiscal and monetary policy have short-run effects on macroeconomic outcomes.