Tools for International Business - summaries
Economics (IBA)
Summary
Year 2 Block 1
Book: Economics (McGraw Hill
Education), 21st edition, McConnell,
Brue & Flynn
Chapters: 33, 36, 40-41.
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,Tools for International Business - summaries
Chapter 33 – Fiscal policy, deficits, and debt
Fiscal policy: consists of deliberate changes in government spending and tax collections
designed to achieve full employment, control inflation, and encourage economic growth; these
changes at the option of the federal government. Two types:
(1) Expansionary Fiscal Policy – happens when recession occurs: government spending
increases, tax reductions, or both, designed to increase aggregate demand and raise
real GDP.
- Budget deficit: government spending in excess of tax revenues.
(2) Contractionary Fiscal Policy – happens when demand-pull inflation occurs:
government spending reductions, tax increases, or both, designed to decrease
aggregate demand and therefore lower or eliminate inflation.
- Budget surplus: tax revenues in excess of government spending.
Taxes reduce spending and aggregate demand. Reduction in spending are desirable when the
economy is moving toward inflation, whereas increases in spending are desirable when the
economy is slumping.
Problems of Fiscal Policy:
- Recognition lag: the time between the beginning of recession or inflation and the
certain awareness that it is actually happening.
- Administrative lag: a significant lag between the time the need for fiscal action is
recognized and the time action is taken; the wheels of democratic government turn
slowly.
- Operational lag: a lag between the time fiscal action is taken and the time that action
affects output, employment, or the price level.
- Political business cycles; swings in overall economic activity and real GDP resulting
from election-motivated fiscal policy, rather than from inherent instability in the private
sector.
- Future policy reversals: policy may fail to achieve its intended objectives if household
expect future reversal of policy.
- Crowding-out effect: an expansionary fiscal policy may increase the interest rate and
reduce investment spending, thereby weakening or cancelling the stimulus of the
expansionary policy.
Public debt: the accumulation of all past federal deficits and surpluses. The deficits have greatly
exceeded the surpluses and have emerged mainly from war financing, recessions, and fiscal
policy.
Government securities: financial instruments issued by the federal government to borrow money
to finance expenditures that exceed tax revenues. There are four types:
1. Treasury bills (short-term securities)
2. Treasury notes (medium-term securities)
3. Treasury bonds (long-term securities)
4. Savings bonds (long-term, nonmarketable securities)
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, Tools for International Business - summaries
The federal government is in no danger of going bankrupt because it needs only to refinance
(not retire) the public debt and it can raise revenues, if needed, through higher taxes.
PowerPoint (lecture) Chapter 33
Discretionary fiscal policy refers to the deliberate manipulation of taxes and government
spending by Congress to alter real domestic output and employment, control inflation, and
stimulate economic growth. ‘’Discretionary’’ means the changes are at the option of the
federal government.
Expansionary policy - Use during a recession:
Increase government spending
Decrease taxes
Combination of both
Create a deficit
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