The government sector plays a major role in the economy. The spending, tax, and transfer policies of local, state, and federal agencies affect aggregate demand and aggregate supply and thus affect the level of real GDP and the price level. An expansionary policy tends to increase real GDP. Such a policy could be used to close a recessionary gap. A contractionary fiscal policy tends to reduce real GDP. A contractionary policy could be used to close an inflationary gap.
Government purchases of goods and services have a direct impact on aggregate demand. An increase in government purchases shifts the aggregate demand curve by the amount of the initial change in government purchases times the multiplier. Changes in personal income taxes or in the level of transfer payments affect disposable personal income. They change consumption, though initially by less than the amount of the change in taxes or transfers. They thus cause somewhat smaller shifts in the aggregate demand curve than do equal changes in government purchases.
There are several issues in the use of fiscal policies for stabilization purposes. They include lags associated with fiscal policy, crowding out, the choice of which fiscal policy tool to use, and the possible burdens of accumulating national debt.
Look up the table on Federal Receipts and Outlays, by Major Category, in the most recent Economic Report of the President available in your library or on the Internet.
Complete the following table:
Category | Total outlays | Percentage of total outlays |
---|---|---|
National defense | ||
International affairs | ||
Health | ||
Medicare | ||
Income security | ||
Social Security | ||
Net interest | ||
Other |
Look up the table on ownership of U.S. Treasury securities in the most recent Economic Report of the President available on the Internet.
Suppose a country has a national debt of $5,000 billion, a GDP of $10,000 billion, and a budget deficit of $100 billion.
Suppose a country’s debt rises by 10% and its GDP rises by 12%.
The data below show a country’s national debt and its prime lending rate.
Year | National debt (billions of $) | Lending rate (%) |
---|---|---|
1992 | 4,064 | 6.0 |
1993 | 4,411 | 6.0 |
1994 | 4,692 | 8.5 |
1995 | 4,973 | 8.7 |
1996 | 5,224 | 8.3 |
1997 | 5,413 | 8.5 |
Suppose a country increases government purchases by $100 billion. Suppose the multiplier is 1.5 and the economy’s real GDP is $5,000 billion.
Suppose a country decreases government purchases by $100 billion. Suppose the multiplier is 1.5 and the economy’s real GDP is $5,000 billion.
Suppose a country decreases income taxes by $100 billion, and this leads to an increase in consumption spending of $90 billion. Suppose the multiplier is 1.5 and the economy’s real GDP is $5,000 billion.
Suppose a country increases income taxes by $100 billion, and this leads to a decrease in consumption spending of $90 billion. Suppose the multiplier is 1.5 and the economy’s real GDP is $5,000 billion.
Suppose a country institutes an investment tax credit, and this leads to an increase in investment spending of $100 billion. Suppose the multiplier is 1.5 and the economy’s real GDP is $5,000 billion.
Suppose a country repeals an investment tax credit, and this leads to a decrease in investment spending of $100 billion. Suppose the multiplier is 1.5 and the economy’s real GDP is $5,000 billion.