Macroeconomics

‭by‬ ‭influencing‬ ‭macroeconomic‬ ‭aggregates‬ ‭that‬ ‭include‬ ‭aggregate‬ ‭demand,‬ ‭real‬ ‭output,‬ ‭and‬ ‭the‬ ‭price‬ ‭level.‬ ‭Since‬ ‭fscal‬‭policy‬‭impacts‬‭aggregate‬‭demand‬ ‭,‬‭it‬‭is‬‭considered‬‭a‬ ‭demand-side‬‭policy‬ ‭.‬ ‭Its‬‭tools‬ ‭include‬‭government‬‭spending‬‭and‬‭taxes‬‭(or‬‭transfers).‬ ‭It‬‭is‬‭also‬‭referred‬‭to‬‭as‬‭a‬ ‭discretionary‬‭policy‬ ‭,‬ ‭meaning‬ ‭that‬ ‭it‬ ‭is‬ ‭one‬ ‭actively‬ ‭implemented‬ ‭by‬ ‭the‬ ‭government‬ ‭to‬ ‭affect‬ ‭AD.‬ ‭For‬ ‭example,‬ ‭the‬ ‭U.S.‬ ‭Federal‬ ‭Government‬ ‭needs‬ ‭the‬ ‭approval‬ ‭of‬ ‭the‬ ‭Congress‬ ‭to‬ ‭use‬ ‭fscal‬ ‭policy‬ ‭tools‬ ‭to‬ ‭achieve‬ ‭macroeconomic objectives.‬ ‭Government Spending and Taxes‬ ‭Recall‬ ‭that‬ ‭government‬ ‭spending‬ ‭(or‬ ‭government‬ ‭expenditure)‬ ‭is‬ ‭an‬ ‭injection‬ ‭into‬ ‭the‬ ‭economy‬ ‭that‬ ‭directly‬ ‭affects‬ ‭AD‬ ‭(component‬ ‭of‬ ‭AD),‬ ‭whereas‬ ‭taxes‬ ‭are‬‭leakages‬‭out‬‭of‬‭the‬‭economy‬‭that‬‭indirectly‬ ‭affect AD by influencing consumption (C), a component of AD.‬

‭The following table lists the various areas and items of government spending and taxes in the U.S.‬

‭Table 1: The Tools of Fiscal Policy in the U.S.‬ ‭Areas of Government Spending‬

‭Types of Tax‬

‭Education‬

‭Personal income tax which affects disposable‬ ‭income by reducing consumption.‬ ‭Corporate tax imposed on frms’ profts, reducing‬ ‭their investment spending.‬ ‭Sales tax imposed on goods or services and‬ ‭collected from their suppliers.‬

‭National defense‬

‭Healthcare coverage for those who are 65 years‬ ‭old and above‬

‭Social security such as retirement pensions‬

‭Property tax imposed on the value of‬ ‭privately-owned property.‬

‭Other transfer payments such as unemployment‬ ‭benefts‬

‭Social insurance tax collected from‬ ‭self-employed individuals and payrolls to support‬ ‭those who are 65 years old and above. This‬ ‭affects wages and the costs of production.‬

‭B. Demand-Side Efects of Fiscal Policy‬ ‭Output‬‭gaps‬‭occur‬‭when‬‭the‬‭economy‬‭is‬‭operating‬‭in‬‭the‬‭short-run‬‭equilibrium‬‭either‬‭below‬‭or‬‭above‬‭the‬ ‭level‬ ‭of‬ ‭full‬ ‭employment‬ ‭(below‬ ‭or‬ ‭above‬ ‭LRAS).‬‭In‬‭the‬‭short‬‭run,‬‭fscal‬‭policy‬‭can‬‭be‬‭implemented‬‭to‬ ‭affect real GDP and the price level by influencing AD.‬ ‭Expansionary Fiscal Policy‬ ‭As‬ ‭observed‬‭in‬‭the‬‭business‬‭cycle,‬‭a‬‭recession‬‭is‬‭an‬‭economic‬‭downturn‬‭associated‬‭with‬‭a‬‭decrease‬‭in‬ ‭the‬ ‭price‬ ‭level,‬ ‭real‬ ‭output,‬ ‭and‬ ‭an‬ ‭increase‬ ‭in‬ ‭unemployment.‬ ‭This‬ ‭indicates‬ ‭that‬ ‭the‬ ‭economy‬ ‭is‬ ‭experiencing‬‭a‬‭recessionary‬‭gap,‬‭where‬‭the‬‭short-run‬‭equilibrium‬‭(intersection‬‭of‬‭AD-SRAS)‬‭is‬‭below‬‭the‬ ‭full‬‭employment‬‭output‬‭(LRAS).‬‭To‬‭address‬‭this,‬‭the‬‭government‬‭may‬‭implement‬‭an‬ ‭expansionary‬‭fscal‬

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