Fiscal Policy: Spending, Taxes, the Multipliers, and Crowding Out

Objectives

• Students will be able to distinguish expansionary from contractionary fiscal policy and match each to a recessionary or inflationary gap.
• Students will be able to calculate the spending and tax multipliers and determine the change in G or T needed to close a stated output gap.
• Students will be able to explain crowding out: deficit borrowing raises the real interest rate and reduces private investment.
• Students will be able to distinguish discretionary fiscal policy from automatic stabilizers and give an example of each.
• Students will be able to draw a correctly labeled AD-AS graph showing the effect of a fiscal-policy action.

Materials (all free, no student accounts needed)

• Fiscal Policy module
• Fiscal-policy sandbox graph
• Draw-the-graph FRQ practice
• Fiscal Policy question set
• Flashcard review

Five-minute warm-up, no prep

Open one of these on the projector. Students say what they think happens to price and quantity before anything moves, lock it in, and then the graph plays out step by step. No accounts, nothing graded or stored.

• Crowding Out: Government Deficit Borrowing
• A Rise in National Saving
• US Interest Rates Rise: The Dollar Appreciates

Warm-up (8 min)

• On the board: 'The CARES Act sent $1,200 to about 160 million people in 2020. Which AD component does that money show up in first, and which way does AD move?' Two minutes, then cold-call.
• Quick vote: is cutting the corporate tax rate fiscal policy or monetary policy? Hold the answer for the mix-up warning during direct instruction.

Direct instruction (30 min)

• Define fiscal policy in one line: Congress using taxes and spending to move AD. List expansionary tools (more G, lower T, more transfers) and contractionary tools (less G, higher T).
• Re-derive both multipliers and connect them to gaps: to close a $100B gap with MPC = 0.8, you need $20B of new spending but a $25B tax cut. Do the arithmetic live.
• Warn on the classic mix-up: Congress cannot lower interest rates and the Fed cannot cut taxes. Circle fiscal (taxes and spending) versus monetary (money supply and rates).
• Explain crowding out with the module's chain: a deficit means the Treasury sells bonds, competing for savings, the real interest rate rises, and some private investment is canceled. Note it shrinks the multiplier.
• Contrast discretionary policy (a new bill, with recognition and passage lags) with automatic stabilizers (progressive taxes, unemployment insurance, SNAP) that work with no new law.

Guided practice (32 min)

• Project /sandbox/fiscal-policy, set the economy in a recessionary gap, and call a student to apply expansionary policy; the class reads off the new output and price level.
• Switch to /sandbox/adas for the same action and ask a second student to name the resulting gap after the AD shift.
• Move to /frq-practice/draw and assign 'Expansionary Fiscal Policy,' 'Household Income Tax Cut,' and 'Austerity Spending Cut'; students draw on devices while the tool checks the AD direction. Circulate for correct price-level and real-GDP labels.
• Cold-call the multiplier: 'MPC = 0.75, close a $240B recessionary gap. How much new G? How large a tax cut?' (G = $60B at multiplier 4; tax cut = $80B at tax multiplier 3). One student shows each on the board.
• Cold-call crowding out: 'The fiscal expansion is deficit-financed. What happens to the real interest rate and private investment?' Have a student trace the loanable-funds chain aloud.

Independent practice (25 min)

• Solo, students complete at least 8 items from the /practice/fiscal-policy set.
• Free-response: an economy is $150B below potential with MPC = 0.8. (a) State whether expansionary or contractionary policy is needed, (b) calculate the required change in G, (c) draw the labeled AD-AS effect, (d) explain in one sentence how crowding out could shrink the actual effect.

Exit ticket

• Name one automatic stabilizer and explain in one sentence how it works without a new law.
• MPC = 0.8. How large a tax cut closes a $100B gap, and why is it larger than the needed spending increase?
• In one sentence, what does crowding out do to the real interest rate and to private investment?

Homework

• Read the Fiscal Policy module on /macro/fiscal-policy, then complete the practice questions embedded in it.
• Use /flashcards to review the fiscal-policy and multiplier terms; complete one review session.

Differentiation

• For early finishers: assign the three-graph challenge (AD-AS, money market, Phillips curve) for a single expansionary action and have them label all three.
• For multiplier strugglers: provide a partially worked table so they fill in the spending-multiplier and tax-multiplier rows rather than recall both formulas cold.
• For a vocabulary scaffold: give a matching sheet pairing each tool (more G, higher T, unemployment insurance) with expansionary, contractionary, or automatic.

Misconceptions to head off

• Belief: the government can lower interest rates as fiscal policy. Correction: interest rates and the money supply are monetary tools; fiscal policy is only taxes and spending set by Congress.
• Belief: a new stimulus bill is an automatic stabilizer. Correction: automatic means no new legislation; a passed bill is discretionary fiscal policy.
• Belief: a tax cut and an equal spending increase move AD by the same amount. Correction: the tax multiplier is one smaller in absolute value because part of the tax cut is saved before it circulates.
• Belief: the budget deficit and the national debt are the same thing. Correction: the deficit is one year's flow; the debt is the accumulated stock, so a smaller deficit still grows the debt.