3.8 Fiscal Policy
Fiscal policy is Congress changing government spending or taxes to shift AD: expansionary closes a recessionary gap, contractionary closes an inflationary gap.
Fiscal policy is the government (Congress and the president — never the Fed) changing spending, taxes, or transfers to steer aggregate demand. Expansionary policy (more G, lower taxes, more transfers) shifts AD right to close a recessionary gap; contractionary policy (less G, higher taxes) shifts AD left to close an inflationary gap.
Government spending hits AD directly and gets the full spending multiplier (1/MPS); tax and transfer changes work through disposable income and get the smaller tax multiplier (−MPC/MPS). To close a $100 billion gap with MPC = 0.8, government needs only $20 billion of new spending — but a $25 billion tax cut.
Discretionary fiscal policy requires new legislation, which brings lags: recognizing the problem, passing the law, and waiting for spending to ripple through. Expansionary policy funded by borrowing also widens the budget deficit — the Unit 5 setup for crowding out.
Key terms for 3.8
Drag the curves yourself — the fastest way to make 3.8 stick.
Practice the math
Mixing fiscal and monetary tools — writing that the government 'lowers interest rates' or the Fed 'cuts taxes.' Fiscal policy is spending and taxes by Congress; interest rates and the money supply belong to the central bank.
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