Introduction to Fiscal Policy

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- [Tyler] When the recession
of 2009 hit,

the federal government tried
to stimulate the American economy.

It cut taxes and increased spending.

In other words, it conducted
expansionary fiscal policy.

Fiscal policy --
the government's policies

on taxes, spending and borrowing --

that's used to try to mitigate
fluctuations in the business cycle,

to even out the booms
and the busts.

But, how is it that
expansionary fiscal policy

is capable of actually working?

Imagine an economy
that's operating at full employment.

Workers have jobs,

and factories are operating
near capacity.

If in that case,
the federal government tries

to increase spending to,
say, build a new road,

then it necessarily has to take away
some people and some capital

from other sectors of the economy.

GDP wouldn't increase,

because there's already
full employment.

So government spending
would simply be crowding out

private spending and investment.

Building the new road?

It may or may not
be a good idea,

depending on how valuable
that road would be.

But still, the increased
government spending would not,

in the short run,
stimulate the economy.

But now, in contrast,

imagine an economy
during a recession.

The fundamental factors
of production are underused.

Labor and capital are unemployed
or underemployed.

Machines and buildings are idle.

In this case, government spending
on a new road

probably would increase GDP.

In fact, an extra dollar
spent during a recession

might even increase GDP
by more than a dollar.

Say, for instance,
the government hires

unemployed construction workers.

These construction workers
then use their new income

to, say, eat out at restaurants.

This causes restaurant owners
to hire more workers,

and these newly employed
waiters and waitresses --

they then spend their money
throughout the economy.

There's a kind of ripple effect,

and the people
who receive that money

in turn spend
more money themselves.

The subsequent increases
in spending

caused by the initial increase
in government spending --

that's known as
the "fiscal multiplier."

Now, expansionary fiscal policy

is not the only kind
of fiscal policy.

The government also conducts
contractionary fiscal policy

by saving during an economic boom --

by either increasing taxes
or by decreasing spending.

At least that's how
fiscal policy is supposed to work.

Later, we'll discuss some
of the political economy issues

of continual deficit spending

and why government surpluses
sometimes are so hard to come by.

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